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Social  Science  UeiNBoofes 

Edited  by  Richard  T.  Ely 


OUTLINES    O.F   ECONOMICS 


SOCIAL  SCIENCE  TEXT-BOOKS 

Edited  by  Richard  T.  Ely 


OUTLINES    OF   ECONOMICS 

By    Richard    T.    Ely,    Ph.D.,    LL.D.     Revised    and 
enlarged  by  the  Author  and  Thomas  S.  Adams, 
Ph.D.,     Max    O.     Lorenz,     Ph.D.,     Allyn     A. 
Young,  Ph.D. 
OUTLINES   OF   SOCIOLOGY 

By  Frank   W.  Blackmar,   Ph.D.,  and  John   Lewis 
Gillin,  Ph.D. 

HISTORY   OF   ECONOMIC    THOUGHT  (Revised  Edi- 
tion) 

By  Lewis  H.  Haney,  Ph.D. 
BUSINESS  ORGANIZATION  AND  COMBINATION 

By  Lewis  H.  Haney,  Ph.D. 
PROBLEMS   OF   CHILD   WELFARE 

By  George  B.  Mangold,  Ph.D. 
SOCIAL   PROBLEMS 

By  Ezra  T.  Towne,  Ph.D. 
THE   NEW   AMERICAN   GOVERNMENT 

By  James  T.  Young,  Ph.D. 

COMPARATIVE   FREE   GOVERNMENT 

By  Jesse  Macy,  LL.D.,  and  John  W.  Gannaway,  M.A. 
AMERICAN   MUNICIPAL  PROGRESS 

By  Charles  Zueblin. 

APPLIED    EUGENICS 

By  Paul  Popenoe  and  Roswell  S.  Johnson,  M.S. 
AGRICULTURAL   ECONOMICS 

By  Henry  C.  Taylor,  M.S.  Agr.,  Ph.D. 
THE   LABOR   MARKET 

By  Don  D.  Lescohier,  Ph.D. 


OUTLINES  OF  ECONOMICS 

(THIRD   REVISED   EDITION) 


BY 

RICHARD   T.   ELY 

PROFESSOR  OF   POLITICAL   ECONOMY   IN   THE   UNIVERSITY  OF   WISCONSIN 

THOMAS    S.  ADAMS 

PROFESSOR   OF   POLITICAL   ECONOMY   IN   THE   SHEFFIELD   SCIENTIFIC 
SCHOOL   OF  YALE   UNIVERSITY 

MAX   O.    LORENZ 

ASSOCIATE   STATISTICIAN,   INTERSTATE   COMMERCE   COMMISSION 

ALLYN   A.   YOUNG 

PROFESSOR   OF   ECONOMICS   AND    FINANCE  IN* 
CORNELL   UNIVERSITY 


Neto  gorfc 
THE   MACMILLAN   COMPANY 


1922 

All  ,'ignts     ■  ,trved 


PRINTED  IN  THE  UNITED  STATES  OF  AMERICA 


Copyright,  1893, 
By  HUNT  &  EATON. 

Copyright,  1908  and  1916, 
By  THE  MACMILLAN  COMPANY. 

COPTBIGHT,   1921. 

By  RICHARD  T.  ELY. 


First  published  elsewhere.  Reprinted  May,  1900;  July,  October, 
1901;  August,  1903;  July,  September,  1904;  July,  1905;  January, 
August,  1906;  July,  1907;  April,  1908 

New  edition,  revised  and  enlarged,  September,  October,  1908; 
January,  August,  11,09;  December,  1910;  August,  1911;  June, 
1912;  May,  1913;  January,  July,  :9t4'.  January.  September, 
twice,  191 5 

Third  edition,  revised  and  enlarged,  September,  1916.     Reprinted 
November,  1916. 

Reprinted  with  corrections,  August,  October,  1917. 


'      .Nr  *    •    -'       .1' 


PREFACE 

The  first  edition  of  the  Outlines  of  Economics,  written  by 

Professor  Ely,  was  published  in  1893.     Four  persons  cooperated 

in  the  preparation  of  a  revised  and  enlarged  edition,  which 

appeared  in  1908.     This  was  in  many  respects  a  new  book, 

although  much  matter  from  the  earlier  edition  was  incorpo- 

,  „  rated  in  it,  and  although  pains  were  taken  to  retain  the  general 

&-  organization  and  especially  the  general  point  of  view  of  the 

older  volume.     The  present  edition  does  not  differ  so  much 

from  its  predecessor  as  that  differed  from  the  first  edition,  but 

it  is,  nevertheless,  the  result  of  a  more  thoroughgoing  revision 

—  than  is  usually  given  to  books  of  this  kind. 

Some  minor  changes  have  been  made  in  the  order  in  which 
the  chapters  appear ;  two  chapters  have  been  omitted ;  and 
a  chapter  on  labor  legislation  has  been  added.  No  chapter 
in  the  book  remains  unaltered,  and  the  larger  part  of  Books  II 
and  III  has  been  virtually  rewritten.  While  the  number  of 
different  subjects  treated  has  been  slightly  reduced,  the  treat- 
ment of  the  more  fundamental  subjects  has  been  considerably 
expanded.  Each  of  us  has  undertaken  the  revision  of  a  definite 
portion  of  the  book  and,  to  secure  unity,  Professor  Young  has 
had  general  editorial  supervision  of  the  revision  as  a  whole. 

Some  of  the  changes  are  such  as  are  necessary  by  reason  of 
eight  years  Of  progress  in  industrial  life,  in  legislation,  and  in 
economic  thought.  Other  changes  are  the  outgrowth  of  the 
experience  gained  in  eight  years'  use  of  the  book  in  university 
and  college  courses.  Among  the  many  persons  to  whom  we 
are  indebted  for  helpful  criticisms  and  suggestions  are  Dr.  John 
Cummings,  Professor  H.  J.  Davenport,  Dr.  C.  S.  Duncan, 
Professor  L.  C.  Gray,  Professor  J.  E.  Le  Rossignol,  Professor 


VI  PREFACE 

W.  C.  Mitchell,  Professor  T.  W.  Page,  Professor  F.  M.  Taylor, 
Mr.  Ray  S.  Trent,  and  Professor  N.  A.  Weston. 

The  instructors  in  charge  of  the  course  in  elementary  eco- 
nomics at  the  University  of  Wisconsin  have  generously  cooperated 
by  submitting  carefully  prepared  lists  of  definite,  well-con- 
sidered, and  pointed  suggestions  for  the  betterment  of  the 
book.  We  make  grateful  acknowledgment  to  Professors  T.  K. 
Urdahl,  W.  I.  King,  and  H.  D.  Simpson,  and  to  Messrs.  Harry 
Jerome,  A.  H.  Hansen,  J.  G.  McKay,  and  F.  L.  Vaughan. 

THE  AUTHORS. 
September,  1916. 


CONTENTS 
BOOK  I.  —  INTRODUCTION 


Preface 


Chapter  I.  —  The  Nature  and  Scope  of  Economics 

Diversity  of  economic  study,  3 ;  Definition  of  economics,  4 ;  A 
social  science,  5 ;  Studies  man  in  process  of  development,  6 ;  Eco- 
nomic laws,  7;  Relation  of  economics  to  other  sciences,  11 ;  Prin- 
cipal divisions  of  economics,  15. 

Chapter  II.  —  The  Characteristics  of  the  Present  Economic  System 

Human  and  physical  conditions  of  economic  activity,  17  ;  Private 
enterprise  and  state  activity,  17;  Division  of  labor  and  exchange, 
19;  Economic  classes,  21 ;  Private  property,  21 ;  Trade-marks,  copy- 
rights, and  patents,  23  ;  Inheritance,  24;  Contract,  25  ;  Vested  in- 
terests, 25;  Freedom,  26;  Competition  and  markets,  28;  Fair 
competition,  29;    Cooperation,  30;   Monopoly,  30;    Custom,  31. 

Chapter  III.  —  The  Evolution  of  Economic  Society 

Basis  of  the  economic  stages,  33;  Direct  appropriation,  34; 
Primitive  man,  35;  Pastoral  stage,  36;  Agricultural  sta^ ,  37; 
Manorial  economy  in  England,  37;  Handicraft  stage,  39;  Gilds, 
39;  Domestic  system,  40 ;  Agricultural  changes,  41 ;  The  mercan- 
tile system,  42  ;   Industrial  stage,  44 ;   Other  classifications,  44. 

Chapter  IV.  —  The  Evolution  of  Economic  Society  (Continued) 

Industrial  Revolution,  47  ;  England  in  1760,  47  ;  Mechanical  in- 
ventions, 49 ;  Agricultural  changes,  50 ;  Effects  of  industrial  revolu- 
tion, 51;  The  factory  system,  51;  Industrial  specialization,  2; 
Evils  of  the  transition,  52;  Competition  and  laissez-faire,  53  ;  Re- 
action against  the  passive  policy,  54 ;  Quality  of  goods,  55 ;  Pro- 
tection of  labor,  55  ;  Labor  organizations,  57  ;  Extension  of  govern- 
ment enterprise,  58;   Summary,  59. 


Vlll  CONTENTS 

Chapter  V.  —  The  Economic  Development  of  the  United  States 
Economic  stages  in  American  industrial  history,  61 ;   Sectional- 
ism, 62 ;    Characteristics  of  the  American  people,  63 ;    Growth  of 
population,  64 ;   Slavery  and  the  negro  problem,  66 ;  Immigration, 
68 ;  Natural  resources,  74 ;  Public  lands,  75. 

Chapter  VI.  —  The  Economic  Development  of  the  United  States 

(Continued) 

Mercantilism  in  America,  79;  English  colonial  policy,  80; 
American  industries  in  1776,  81 ;  The  Industrial  Revolution  in 
America,  81 ;  The  development  of  agriculture,  84;  Manufactures, 
86;  Transportation,  00;  The  labor  movement,  93 ;  State  regula- 
tion of  industry,  96. 

BOOK  II.  —  PRINCIPLES  AND  PROBLEMS 
PART  I.  —  PRODUCTION  AND   CONSUMPTION; 

Chapter  VIX  —  Elementary  Concepts 

Motives  in  economic  activity,  103 ;  Utility,  105 ;  Free  and  eco- 
nomic goods,  105  ;  Effort  and  waiting,  106 ;  Risk,  106 ;  Personal 
qualities  as  goods,  107 ;  Wealth  and  income,  108 ;  Individual  and 
society,  109 ;  Wealth  and  value,  109 ;  Capital  and  other  forms  of 
wealth,  no;  Capital  goods  and  capital  value,  no;  Social  and  in- 
dividual capital,  in ;  National  wealth  and  national  dividend,  in. 

Chapter  VIII.  —  Production 

Production  defined,  116;  Production  of  values,  118;  Factors  of 
production,  119;  Saving  and  capital  formation,  122;  Production 
and  sacrifice,  124;  Organization  of  productive  factors,  123;  The 
entrepreneur,  1 23  ;  Division  of  labor,  124;  Advantages  of  division 
of  labor,  126 ;  Effects  upon  the  worker,  127 ;  Territorial  division  of 
labor,  128;  Productive  organization  of  the  American  people,  129. 

Chapter  DC.  —  Consumption 

Consumption  defined,  132;  Productive  and  final  consumption, 
132;  Human  wants,  133;  Law  of  diminishing  utility,  133;  Mar- 
ginal utility,  135  ;  Subjective  value,  137 ;  Economic  order  of  con- 
sumption, 139 ;  Future  wants,  140;  Consumption  and  saving,  142 ; 
Alleged  present  consumption  of  future  products,  142 ;  Luxury,  143 ; 
Harmful  consumption,  144;  Statistics  of  consumption,  144;  Con- 
sumption and  sacrifice,  146;  Cost  of  production,  expense  of  produc- 
tion, and  opportunity  cost,  148. 


CONTENTS  IX 

PART  II.  — VALUE  AND   EXCHANGE 
Chapter  X.  —  Value  and  Price 
Meaning  and  significance  of  value,  151 ;   The  market,  153;   Ex- 
change value  and  subjective  value,  155  ;  Supply  and  demand,  156 ; 
Nature  of  demand,  156;    Elasticity  of  demand,  159;    Nature  of 
supply,  162 ;   The  determination  of  price,  164. 

Chapter  XI.  —  Value  and  Price  {Continued) 
Prices  and  the  expenses  of  production,  167  ;  Normal  price,  169 ; 
Different  conditions  of  supply,  170;  Fixed  and  variable  expenses, 
174;  Joint  expenses  of  production,  179;  Surplus  of  bargaining,  181 ; 
Non-reproducible  goods,  182;  Retail  prices,  182  ;  Public  authority 
and  value,  183 ;  Imputed  value,  184 ;  Valuation  of  production 
goods,  185 ;  Other  theories  of  value,  186. 

Chapter  XII.  —  Monopoly 

The  idea  of  monopoly,  189;  Classification  and  causes,  193; 
Social  and  natural,  195  ;  Monopoly  price,  200 ;  Effect  of  a  tax,  202 ; 
Relation  of  demand  to  monopoly  price,  203 ;  Class  price,  204 ; 
Monopoly  price,  high  price,  205 ;  Monopolies  and  distribution  of 
wealth,  207 ;  Public  policy  toward  monopolies,  208. 

Chapter  XIII.  —  Business  Organization 

The  meaning  of  "business,"  212;  The  nature  of  business  units, 
212;  The  business  unit  in  accounting,  213;  The  individual  entre- 
preneur, 214;  Partnerships,  215;  The  business  corporation,  216; 
The  corporation  charter,  217;  Lack  of  uniformity  in  state  laws, 
218;  Corporation  capital  and  capitalization,  219;  Overcapitaliza- 
tion, 221 ;  Form  of  capitalization,  225  ;  Corporation  management, 
226;  Advantages  of  the  corporation,  228;  Social  aspects  of  cor- 
porations, 228;  Trusts,  230;  Causes  of  combination,  232;  Anti- 
trust laws,  235 ;  Unfair  competition,  239 ;  Public  policy  towards 
industrial  combinations,  243;  Federal  control  of  Corporations, 
245 ;   Industrial  combinations  in  other  countries,  245. 

Chapter  XIV.  —  Money 

Metallic  money,  248;  Coinage,  249;  The  meaning  of  "money," 
250;   The  media  of  evrhiiii  ,  .    The  monetary  standard,  255  ; 

Seigniorage,  255,  Limited  coinage.  s<»;  Bimetallism,  260;  Bi- 
metallism in  the  United  States,  263  ;  The  gold-exchange  standard, 
269;  Government  paper  money,  271 ;  Colonial  and  Revolutionary 
bills  of  credit,  273;  The  greenbacks,  273;   Fiat  money,  278. 


CONTENTS 

Chatter  XV.  —  Credit  and  Banking 

Credit  transactions,  282;  Personal  credit,  285;  Bank  credit, 
286 ;  Bank  notes,  200 ;  State  banks  of  ipsue,  200 ;  National  bank- 
ing system,  291;  The  reserve  system:  jqi;  New  York  money 
market,  293;  Speculation,  295;  Independent  treasury  system, 
297 ;  The  movement  of  money,  298 ;  Inelastic  currency,  300 ;  In- 
elastic reserves,  301 ;  Absence  of  centralized  control,  303 ;  Steps 
toward  reform,  304 ;  Federal  reserve  system,  307  ;  SiMe  and  private 
banks,  313. 

Chapter  XVI.  —  Other  Problems  in  Money  a\X  Banking 

The  value  of  money,  317 ;  Quantity  of  money  and  \hs  values  of 
money,  319;  Equation  of  exchange,  321;  Mechanism  of  general 
changes  in  prices,  325;  Industrial  uses  of  gold,  327;  Expenses  0$ 
gold  production,  328;  Increase  in  gold  production,  329;  Effects  oi 
changes  in  prices,  331;  Crises,  333;  Standard  of  deferred  pay- 
ments, 336 ;  Index  numbers,  337. 

Chapter  XVII.  —  International  Trade 

Foreign  exchange,  345;  Regulation  of  the  gold  supply,  350; 
Balance  of  trade,  354;  Restriction  of  interpational  trade,  358; 
*dvantages  of  international  trade,  361. 

Chapter  XVIII.  —  Protection  and  Free  Trade 

The  case  for  protection,  368;  Arguments  of  free  traders,  374; 
General  considerations,  380;   Conclusions,  381. 

PART  III.  —  DISTRIBUTION 
Chapter  XIX.  —  Distribution  as  an  Economic  Problem 

The  problem  of  distribution,  384;  Distribution  controlled  b.V 
existing  institutions,  386 ;  Money  incomes,  387 ;  Law  of  diminish- 
ing productivity,  388 ;  Marginal  product  of  labor,  390 ;  Marginal 
products  of  land  and  capital,  392;  Marginal  productivity  and  the 
prices  of  production  goods,  398;  The  meaning  of  "productivity," 
400 ;  Social  aspects  of  diminishing  productivity,  404. 

Chapter  XX.  —  The  Rent  of  Land 

Rent  defined,  407 ;  The  services  of  land,  408 ;  Rent  under  uni- 
form intensivity  of  cultivation,  410 ;  Rent  under  actual  conditions, 
413 ;  The  different  uses  of  land,  416 ;  The  capitalization  Of  rent, 
418;  Rent  and  social  progress,  419;  The  unearned  increment, 
4a* ;  Urban  lands,  426. 


%A 


CONTENTS  XI 

Chapter  XXI.  —  The  Wages  or  Labor 

Wages  as  the  price  of  labor,  427;  Demand  for  labor,  428;  Labor- 
saving  machinery,  430;  Supply  of  labor,  431 ;  Growth  of  popula- 
tion, 434;  Subsistence  theory  of  wages,  437 ;  The  standard  of  life 
and  wages,  438 ;  Supply  of  labor  in  ditierent  occupations,  439 ;  The 
wage  contract,  442. 

Chapter  XXII.  —  Labor  Problems 

Types  of  labor  organizations,  444;  Economic  justification  of 
labor  organizations,  445  ;  Labor  organizations  and  monopoly,  446 ; 
Methods  and  policies  of  labor  organizations,  447 ;  The  closed  shop, 
448 ;  Limitation  of  output,  449 ;  Educational  and  fraternal  activi- 
ties, 451;  The  strike,  452 ;  Employers' associations,  454;  Trade 
arbitration,  457  ;  Voluntary  arbitration,  458 ;  Compulsory  arbitra- 
tion, 459;  Profit  sharing,  461;  Industrial  democracy,  463;  Co- 
operation, 465 ;  The  future  of  the  union,  469. 

Chapter  XXIII.  —  Labor  Legislation 

Freedom  of  contract,  conspiracy,  and  injunctions,  472;  Child 
labor  laws,  476 ;  The  labor  of  women,  479 ;  Minimum  wage  laws, 
480 ;  Factory  acts,  484 ;  Employers'  liability,  486 ;  Philosophy  of 
labor  legislation,  488. 

Chapter  XXIV.  —  Interest 

Interest  defined,  493 ;  Inadequate  explanations,  494 ;  How  in- 
terest is  possible,  495 ;  Why  interest  is  necessary,  496 ;  Invest- 
ment, 499 ;  Replacement,  501 ;  Shifting  of  investment,  502 ; 
Expense  and  price  of  capital,  504;  Free  and  specialized  capital, 
506;  Capital  and  land,  507 ;  Capital  and  consumption  goods,  512; 
Capital  and  wages,  512;  Competitive  investment,  513;  The 
flow  of  money  income,  515;  The  annual  product  and  the  social 
dividend,  517;  Sources  of  investment  funds,  523;  The  interest  rate, 
521 ;  Gross  and  net  interest,  523 ;  Usury  laws,  524. 

Chapter  XXV.  —  Profits 

Profits  a  surplus,  525;  Entrepreneur's  wage,  526;  Pure  profits 
impossible  under  certain  conditions,  527;  Sources  of  pure  profits, 
528;  Marginal  productivity  and  profits,  532;  Profits  for  the  in- 
dustry and  profits  for  the  establishment,  533;  Good-will,  535! 
The  relation  of  risks  to  profits,  536 ;  The  entrepreneur,  537;  Profits 
and  the  defense  of  the  competitive  system,  538. 


Xll  CONTENTS 

Chapter  XXVI.  —  The  Personal  Distribution  of  Wealth 
Wealth  and  income,  542 ;  Absolute  and  relative  well-being,  542 ; 
Concentration  of  wealth  and  large-scale  production,  542  ;  Methods 
of  measuring  concentration,  543;  Statistics  of  distribution,  544; 
Causes  of  poverty  and  riches,  549;  Is  greater  diffusion  possible? 
551;  Modifying  the  methods  of  wealth  acquisition,  553. 

PART  IV.  —  SELECTED  ECONOMIC   PROBLEMS 

Chapter  XXVII.  —  Transportation  Economics 

Scope  and  significance,  557;  Nature  of  the  railway  industry, 
558;  Railway  competition,  560;  Pooling  and  consolidation,  561 ; 
The  movement  of  rates,  563 ;  The  level  of  rates,  565 ;  Relative 
rates,  567;  Distance,  570;  Government  ownership,  571 ;  Regula- 
tion, 573;  The  Interstate  Commerce  Commission,  574. 

Chapter  XXVIII.  —  Insurance 

Nature  of  insurance,  577  ;  Origin  and  development,  578;  Forms 
of  insurance  organization,  580;  Life  tables,  581;  Reserve,  583; 
Surplus,  583  ;  Endowments,  584 ;  Industrial  insurance,  585  ;  State 
insurance,  585 ;  State  regulation,  586 ;  Social  insurance,  587 ; 
Workmen's  compensation,  588;  Sickness  insurance,  591;  Old-age 
insurance,  592 ;  Unemployment  insurance,  592 ;  Objections  to 
social  insurance,  593. 

Chapter  XXIX.  —  Agricultural  Problems 

Size  of  farms,  596 ;  Ownership  and  tenancy,  603 ;  Farm  labor, 
606 ;  Farm  indebtedness  and  agricultural  credit,  609 ;  Tenancy  vs. 
encumbered  ownership,  615;  Marketing  of  farm  products,  618; 
Speculation,  622. 

Chapter  XXX.  —  Socialism 

Socialism  denned,  627;  Distributive  justice,  627;  Varieties  of 
socialism,  628;  Communism,  631;  Socialism  an  extension  of 
existing  institutions,  632;  The  strength  of  socialism,  632;  The 
weakness  of  socialism,  634 ;  The  socialist  movement,  636 ;  Anar- 
chism, 638. 

BOOK   III.  — PUBLIC   FINANCE 

Chapter  XXXI.  —  Public  Expenditures 

Natuie  and  significance  of  public  finance,  643 ;  Public  and  pri- 
vate expenditures  contrasted,  646 ;  The  proper  proportion  between 
the  total  income  of  society  and  public  expenditures,  648 ;  Economy 


CONTENTS  xiii 

the  total  income  of  society  and  public  expenditures,  648;  Economy 
vs.  parsimony,  652;  Historical  development,  654;  Development 
of  public  expenditures  with  respect  to  regularity  and  irregularity. 
659;  Classification  of  public  expenditures,  660. 

Chapter  XXXII.  —  Public   Receipts  from  Loans  and  Government 

Ownership 

Public  debts,  666;  Public  domains,  671;  Land  policy  of  the 
United  States,  673  ;  Forest  lands,  674 ;  Mineral  lands,  675  ;  Success 
of  our  land  policy,  677  ;  Land  nationalization  and  municipalization, 
679;   Public  industries,  682. 

Chapter  XXXIII.  —  Public  Receipts:    Derivative    Revenues,  Fees, 
Special  Assessments,  and  Taxes 

Definitions,  689;  Fees,  690;  Special  assessments,  692;  Taxes, 
694;  Justice  in  taxation,  696;  Progressive  taxation,  699;  Direct 
and  indirect  taxes,  702  ;  The  shifting  of  taxes,  703. 

Chapter  XXXIV.  —  Public  Receipts:    Federal,    State,   and   Local 

Taxes 

Constitutional  limitations,  710 ;  Use  of  direct  taxes  by  the  federal 
government,  712;  Customs  duties,  713;  Internal  revenue  duties, 
717;  Taxes  on  transactions,  719;  Income  taxes,  720;  Inheritance 
taxes,  723;  General  property  tax,  726;  Corporation  taxes,  731; 
Business  and  license  taxes,  733;  Poll  taxes,  734;  A  balanced 
revenue  system,  735. 

Appendix  A:  History  of  Economic  Thought  >  74* 
Appendix  B  :  Suggestions  for  Students  and  Teachers  .  .  -754 
Index  .  761 


BOOK  I 
INTRODUCTION 


OUTLINES  OF  ECONOMICS 

CHAPTER  I 

THE   NATURE   AND   SCOPE   OF  ECONOMICS 

The  most  striking  characteristics  of  the  great  field  of  knowl- 
edge the  Outlines  of  which  we  attempt  to  sketch  in  the  present 
volume  are  its  rich  diversity  and  spacious  amplitude.  Start- 
ing from  psychology  in  its  analysis  of  the  human  needs  which 
explain  or  condition  wealth,  it  traverses  the  entire  field  of  social 
activities  and  institutions  arising  from  man's  efforts  to  supply 
his  material  needs.  It  touches  on  one  side  the  physical  sciences, 
from  which  it  borrows  some  of  its  most  fundamental  prin- 
ciples ;  occupies  joint  territory  at  places  with  politics,  ethics, 
and  law,  although  their  respective  jurisdictions  are  in  the  main 
distinct ;  and  forms  at  once  the  most  fertile  and  most  thoroughly 
developed  province  of  the  broad  science  of  human  society. 
Within  its  borders,  if  we  may  continue  to  compare  the  scientific 
possibilities  of  economics  with  the  natural  resources  of  an  opu- 
lent territory,  opportunity  is  offered  for  the  exercise  of  every 
mental  aptitude  and  every  scientific  method.  The  historian's 
gift  is  needed  to  unravel  the  past  and  trace  the  development 
of  the  industrial  institutions  whose  present-day  problems,  in 
turn,  offer  indefinite  scope  for  the  studies  of  the  more  practical 
student  with  a  taste  for  administration  or  business  manage- 
ment. For  the  legal  mind  there  are  the  subtle  problems  of 
property,  inheritance,  labor  legislation,  and  corporation  con- 
trol ;  for  the  mathematically  inclined,  insurance  and  modern 
statistics;  for  students  with  practical  political  interests,  the 
tariff,  currency  reform,  and  a  score  of  important  problems  in 
which  economics  and  politics  are  inextricably  interwoven ;   for 

3 


4  OUTLINES  OF  ECONOMICS 

the  philanthropic,  unemployment,  accident  insurance,  and  a 
number  of  social  problems  growing  out  of  the  maladjustments  of 
modern  industry.  Animating  the  entire  subject,  blended  with 
the  love  of  truth  for  truth's  sake  common  to  all  sciences,  is  the 
persistent  hope  that  by  systematic  study  we  may  eventually 
abolish  the  material  poverty  which  deadens  and  dwarfs  the 
lives  of  millions  of  our  fellows.  Economics  is  a  science,  but 
something  more  than  a  science ;  a  science  shot  through  with  the 
infinite  variety  of  human  life,  calling  not  only  for  systematic, 
ordered  thinking,  but  for  human  sympathy,  imagination,  and 
in  an  unusual  degree  for  the  saving  grace  of  common  sense. 

To  define  such  a  subject  adequately  in  a  few  sentences  is 
manifestly  impossible.  It  is  frequently  said  that  economics 
treats  of  man's  efforts  to  earn  a  living,  and  this  definition  is 
not  inaccurate  if  by  "  man  "  we  understand  "  mankind,"  and 
if  we  fully  appreciate  that  the  individual's  efforts  to  turn  an 
honest  penny's  profit  receive  but  little  attention  in  comparison 
with  the  community's  efforts  to  feed,  clothe,  and  shelter  itself. 
Satisfaction  of  social  need,  and  not  individual  profit,  is  the 
objective  point  of  the  science.  So,  similarly,  economics  has 
been  characterized  as  the  philosophy  of  human  industry;  and 
this  description  is  illuminating  provided  we  interpret  "  indus- 
try "  broadly  enough.  Even  the  old  traditional  definition,  that 
economics  is  the  science  of  wealth,  is  true  enough  if  we  clearly 
understand  that  there  can  be  no  wealth  without  man,  and  that 
the  science  which  deals  with  wealth,  so  far  from  being  a  "  gospel 
of  mammon,"  necessarily  begins  and  ends  in  the  study  of  man. 
As  we  prefer  to  define  it,  however,  economics  is  the  science  which 
treats  of  those  social  phenomena  that  are  due  to  the  wealth-getting 
and  wealth-using  activities  of  man. 

Economics  treats  of  Man.  —  The  supreme  importance  of 
man  in  the  study  of  wealth  has  not  always  been  appreciated 
by  those  who  have  expounded  the  science.  Too  often  they 
have  considered  man  simply  as  a  producer  of  wealth,  the  one 
"  by  whom  "  the  necessaries,  conveniences,  and  luxuries  of 
life  are  created,  whereas  the  infinitely  greater  truth  is  that  man 
is  the  one  "  for  whom  "  they  are  all  produced.     Of  course  no 


THE  NATURE  AND   SCOPE  OF  ECONOMICS 

one  denies  this  truth,  but  one  might  almost  as  well  deny  it  as 
to  leave  it  out  of  account.  The  result  of  such  neglect  is  that 
men  devise  with  great  skill  rules  by  which  man  may  be  made  the 
best  possible  manufacturing  machine.  It  sometimes  quite 
escapes  the  notice  of  these  persons  that  in  making  man  the  best 
possible  manufacturing  machine  they  may  make  him  a  very 
poor  sort  of  a  man ;  that  in  teaching  him  to  supply  his  wants 
very  bountifully  they  may  prevent  his  developing  and  correct- 
ing those  same  wants.  They  forget  that  there  are  two  kinds 
of  poverty  —  one  a  lack  of  goods  for  the  higher  wants,  the  other 
a  lack  of  wants  for  the  higher  goods.  To  become  rich  in  goods 
while  losing  at  the  same  time  the  power  to  profit  by  them  is 
unfortunately  one  of  the  commonest  retrogressions  in  human 
experience.  We  do  not  mean  that  the  whole  problem  of  human 
development  is  the  subject  of  economics,  but  simply  that  man- 
hood, rounded  human  development,  and  the  equitable  organiza- 
tion of  human  relationships  are  the  objects  of  all  social  sciences, 
and  none  must  consider  its  subject  so  narrowly  as  to  exclude 
these  objects. 

Another  common  mistake  has  been  to  regard  as  of  chief 
importance  the  economic  activities  of  one  particular  class, 
especially  the  employer.  Other  men  were  treated  simply  as 
"  a  factor  in  production."  An  English  writer  speaks  of  dear 
labor  as  one  of  the  chief  obstacles  to  England's  economic  pros- 
perity. Could  anything  be  more  utterly  an  oversight  of  general 
human  well-being?  Dear  labor  should  be  the  very  goal  of 
England's  economic  effort,  for  that  means  abundant  supply 
of  the  wants  of  the  great  mass  of  her  people ;  and  the  fact  that 
labor  is  dear,  so  far  from  being  an  obstacle  to  prosperity,  is 
the  very  proof  and  substance  of  that  prosperity.  A  glance  at 
history  indicates  that  men  have  made  these  mistakes  not  only 
in  theory  but  in  practice.  Industries  have  been  developed  to 
majestic  proportions  while  man  was  sinking  into  deeper  deg- 
radation; wealth  has  at  times  grown  at  the  expense  of  that 
human  weal  in  whose  service  it  won  its  name. 

Economics  treats  of  Man  in  Society.  —  This  is  one  of  those 
truisms  which  only  history  can  make  real  to  us.     As  we  pass 


6  OUTLINES  OF  ECONOMICS 

from  the  savage  and  cannibal,  up  through  all  the  stages  of 
development,  we  find  an  ever-increasing  interdependence 
among  men.  Man  is  least  dependent  when  he  wants  least, 
cares  least,  has  least,  knows  least,  and  is  least.  With  every 
betterment  of  condition  and  character  he  is  more  dependent 
than  before,  more  dependent  and  yet  more  free.  The  beginnings 
of  barter  are  a  confession  of  mutual  need ;  the  coining  of  money 
is  a  declaration  of  dependence  to  all  men.  We  look  with  pride 
upon  a  century  of  progress,  but  that  progress  has  consisted  in 
little  else  than  a  growth  of  dependence,  an  ever-increasing  de- 
parture from  that  rude  kind  of  literal  self-help  in  which  each 
one  does  everything  for  himself.  Our  fathers  drew  water,  each 
for  himself,  in  "  the  moss-covered  bucket,"  while  our  mothers 
dipped  candles  for  the  evening's  light.  If  one  was  negligent, 
the  rest  did  not  suffer.  Today  a  network  of  pipes  radiates  from 
a  common  center  to  enter  a  thousand  households.  An  engi- 
neer makes  a  blunder  at  the  station,  and  thousands  are  in  dark- 
ness or  drought.  Progress  is  a  passage  from  independence  to 
dependence,  from  distrust  to  confidence,  from  hostility  to  amity, 
from  helplessness  to  helpfulness,  while  the  great  law  of  social 
solidarity  gains  ever-increasing  importance.  Our  science,  then, 
is  interested  primarily  in  man  in  his  relations  to  others,  and 
not  in  man  by  himself.  Moreover,  as  a  science  which  studies 
the  present  in  order  that  it  may  predict  and  prepare  for  the 
future,  and  discovering  that  interdependence  is  the  law  of 
progress,  it  must  not  hesitate  to  shape  its  principles  with  refer- 
ence to  a  solidarity  which  shall  grow  more  rather  than  less, 
stronger  rather  than  weaker. 

Economics  treats  of  Man  as  in  Process  of  Development.  — 
Few  truths  are  more  easily  admitted  or  more  persistently  ig- 
nored than  that  of  change  in  human  life  and  condition.  His- 
tory makes  it  real.  Man  now  wanders  about  by  force  of 
necessity  and  age-long  habit,  now  starves  rather  than  be  moved 
from  his  home.  Land  is  now  free  to  all,  now  parceled  out  with 
well-nigh  absolute  right  of  individual  possession.  The  seem- 
ingly eternal  features  of  the  social  structure  are  gone  in  a  few 
generations.     Nothing   so   invalidates   theories,   laws,   general 


THE  NATURE  AND   SCOPE  OF  ECONOMICS  7 

principles,  institutions,  and  enterprises  as  this  great  law  of 
change  of  which  we  seldom  take  full  account.  Take,  for  in- 
stance, bequests.  Nothing  is  commoner  than  for  a  man  to 
leave  a  legacy  under  specified  and  detailed  regulations,  binding 
for  all  time.  One  leaves  money  to  endow  a  religious  service 
in  a  language  which  in  a  few  generations  no  one  understands ; 
another  founds  a  college  to  teach  certain  doctrines  which  in  a 
century  no  one  believes ;  and  so  on  indefinitely.  These  and  a 
thousand  other  laborious  efforts  of  statesman,  warrior,  or 
philosopher  quite  lose  their  worth  for  the  future  because  their 
authors  assumed  that  the  future  would  be  like  their  present. 
Even  the  wages  system  and  the  division  between  capital  and 
labor  which  seem  rooted  in  the  constitution  of  society  are  scarcely 
two  centuries  old  as  a  general  system.  One  must  never  forget 
in  the  study  of  economics  that  the  phenomena  with  which  it 
deals  are  pervaded  by  the  spirit  of  life,  moving  forward  or  back- 
ward, progressing  or  decaying,  under  those  influences  which 
control  the  rise  and  fall  of  social  institutions.  The  science  is 
biological  rather  than  mechanical. 

The  Laws  with  which  Economics  Deals.  —  The  evolutionary 
character  and  complexity  of  economic  phenomena,  which  ac- 
count for  much  of  the  charm  of  the  subject,  endow  it  also  with 
unusual  difficulties.  Conclusions  true  for  one  generation  are 
invalid  in  the  next.  Terms  and  definitions  appropriate  to  one 
stage  of  industry  are  misleading  in  a  succeeding  stage.  Gen- 
eralizations valid  for  one  nation  and  government  are  inappli- 
cable to  another.  Even  those  laws  or  uniformities  which  the 
science  prizes  as  the  finest  product  of  its  research  are  but  state- 
ments of  probabilities  —  declarations  of  what  is  most  likely  to 
occur  for  the  mass  of  men  in  the  long  run  under  certain  specified 
circumstances. 

In  no  department  of  knowledge,  consequently,  is  there  greater  need  of 
temperate  statement  and  of  that  humility  of  mind  which  is  the  surest  safe- 
guard against  bigotry  and  dogmatism.  No  system  of  economics  is  appli- 
cable unchanged  to  all  times  and  all  places  :  the  premises  of  the  arguments 
change;  the  ingredients  of  nearly  every  problem  present  themselves  in 
different  proportions ;  and  the  conditions  of  almost  every  question  vary  from 


8  OUTLINES  OF  ECONOMICS 

country  to  country  and  from  generation  to  generation.  The  student  must 
not  expect  rules  of  thumb  by  which  he  can  decide  offhand  the  economic  prob- 
lems of  the  particular  city  or  country  district  in  which  he  is  for  the  moment 
interested.  No  general  treatise  on  economics  can  authoritatively  decide 
the  practical  problems  of  particular  times  and  places;  although  the  econ- 
omist, before  all  other  students,  is  forced  to  deal  with  practical  problems. 
What  such  a  treatise  can  do  is  to  point  out  mistakes  of  logic  common  in  the 
current  discussions  of  economic  questions,  call  attention  to  obscure  factors 
—  sometimes  of  great  importance  —  which  the  practical  man  is  likely  to 
overlook,  give  solutions  of  typical  problems  which  are  likely  to  arise,  and 
thus  afford  a  training  which  will  assist  the  student  in  solving  practical 
problems  for  himself. 

The  peculiar  and  distinctive  office  of  the  economic  scientist,  however,  is 
to  emphasize  the  less  tangible  truths,  the  remoter  consequences,  the  deeper 
and  consequently  less  obvious  forces  of  economic  society.  The  impulses 
of  the  moment,  the  immediate  demands  of  the  hour,  the  present  "fact"  that 
stares  us  in  the  face  (and  sometimes  blinds  us),  are  not  likely  to  lack  vigorous 
champions ;  and  to  preserve  the  balance  there  is  need  of  a  craft  of  thinkers 
far  enough  removed  from  the  battle  to  preserve  the  wider  outlook,  mindful 
of  the  lessons  of  the  past,  jealous  for  the  rights  of  the  future,  insistent  upon 
the  less  obvious  truths.  This  is  why  economics  so  frequently  appears  to 
the  practical  man  strained  and  academic.  This  impression  arises  from  a 
difference  of  emphasis  which  in  the  main  is  as  salutary  as  it  is  inevitable. 
The  academic  quality  of  the  economist's  work  arises  sometimes  from  igno- 
rance, sometimes  from  pedantry,  but  more  frequently  from  his  courageous 
insistence  upon  the  importance  of  the  less  tangible  truths  and  the  distant 
consequences  of  present  action. 

Is  not  economics,  then,  a  science  based  upon  natural  law? 
The  question  is  largely  a  verbal  one.  What  do  we  mean  by 
natural  law?  In  the  narrowest  sense  natural  laws  are  the 
habits  of  nature  which  are  subject  to  absolutely  no  variation. 
Such  are  gravitation  and  chemical  affinity;  and  the  sciences 
based  upon  such  laws  —  astronomy,  physics,  and  chemistry  — 
were  the  first  to  develop,  and  have  attained  a  maximum  degree 
of  exactitude.  The  term  "  science  "  is  sometimes  used  in  a 
way  to  imply  only  sciences  of  this  character.  These  sciences 
are  more  properly  known  as  exact  sciences,  and  they  are  char- 
acterized by  the  fact  that  the  relations  with  which  they  deal 
can  usually  be  expressed  quantitatively. 

When  we  come  in  contact  with  life,  however,  and  especially 
with  its  higher  forms,  the  exactness  with  which  an  astronomer 


THE  NATURE  AND  SCOPE  OF  ECONOMICS  9 

predicts  an  eclipse  or  a  chemist  anticipates  a  reaction  becomes 
impossible.  Not  that  life  is  without  laws;  very  far  from  it. 
There  is,  in  the  first  place,  the  basis  of  physical  nature,  with  its 
perfect  regularity,  upon  which  all  life  rests  and  to  which  it 
must  conform.  Then,  too,  there  are  laws  governing  life 
directly  and  pertaining  to  it.  These  form  the  subject  of  the 
group  of  sciences  known  as  biology.  We  must  remember, 
however,  that  all  we  can  say  of  natural  laws  is  that  they  are 
habits,  apparent  regularities  or  uniformities  in  the  succession  of 
events ;  not,  so  far  as  we  know,  compulsory  necessities  of  nature. 
And  the  laws  of  life  seem  to  differ  from  those  of  inanimate  nature 
in  that  they  are  not  quite  invariable  habits.  Variability  seems 
to  be  inherent  in  life,  increasing  as  life  rises  in  the  scale  of 
development.  It  is  often  assumed,  to  be  sure,  that  these  laws 
are  as  invariable  as  any  other,  and  that  this  seeming  variability 
is  only  a  greater  complexity  which  we  do  not  yet  understand. 
However  that  may  be,  the  result  is  the  same  for  the  present. 
The  sciences  of  life  are  not  exact  in  the  sense  we  have  defined. 
We  must  further  note  that  in  so  far  as  a  science  deals  with  facts 
which  seem  to  be  governed  by  no  invariable  law,  or  whose  law 
has  not  been  discovered,  it  must  content  itself  with  a  description 
of  this  part  of  its  subject.  Thus  we  have  the  term  "  descriptive 
science."  We  might  better  speak  of  the  descriptive  part  of  a 
science,  for  all  sciences  are  able  in  part  to  reduce  their  facts  to 
law. 

What  has  been  said  of  the  sciences  dealing  with  life  applies 
to  an  even  greater  extent  to  those  sciences  which  deal  with  man. 
It  is  true  that  within  certain  limits  man  is  governed  by  ab- 
solutely invariable  laws.  He  is  as  much  bound  by  gravitation 
as  anything  else,  and  if  he  falls  over  a  precipice,  we  can  predict 
the  results  as  certainly  as  though  a  stone  fell  over.  But,  with- 
out entering  the  bog  of  discussion  as  to  the  nature  of  human 
freedom,  we  may  safely  assume,  for  practical  purposes,  that 
man  is  also,  within  certain  limits,  a  law  unto  himself.  No- 
where do  we  find  an  element  of  variability  so  great  and  so  seem- 
ingly ultimate  as  here.  We  must  remember,  therefore,  that  the 
sciences  which  deal  with  man  deal  with  a  being  who  is  modified 


IO  OUTLINES  OF  ECONOMICS 

by  his  environment,  but  who  has  the  power  of  modifying  that 
environment  by  his  own  conscious  effort. 

Let  us  consider  very  carefully  what  this  means.  It  does  not 
mean  simply  that  man  modifies  his  environment  because  he 
has  been  modified  by  it  and  so  reacts  upon  it,  just  as  things  do 
when  they  come  in  contact.  If  we  accept  this  view,  we  shall 
come  to  Herbert  Spencer's  theory  of  natural  selection.  The 
forces  at  work  accomplish  their  own  results,  according  to  this 
theory,  whether  man  will  or  will  not,  simply  by  natural  action 
and  reaction.  This  implies  that  man  is  modified  by  his  envi- 
ronment, and  that  he  in  turn  modifies  that  environment  with- 
out conscious  effort.  This  theory  is  based  on  an  assumption 
that  man  has  no  power  of  initiating  an  influence,  and  consist- 
ently concludes  that  social  development,  like  geological  develop- 
ment, must  be  left  to  work  itself  out.  Spencer,  however,  goes 
farther,  and  stoutly  maintains  that  man,  by  conscious  effort, 
especially  by  collective  or  state  effort,  not  only  does  not  help 
this  development,  but  actually  hinders  it.  In  this  the  whole 
theory  is  abandoned,  for  it  is  plain  that  if  man  by  conscious 
effort  can  hinder  a  process,  he  can  help  that  process  in  the  same 
way,  if  he  only  has  enough  wisdom  and  sense.  These  it  is  the 
purpose  of  science  to  give  him. 

In  opposition  to  the  theory  of  natural  selection,  or  unconscious 
development,  has  been  urged  the  theory  of  artificial  selection,  or 
conscious  development.  Ages  of  natural  selection  made  of 
the  potato  a  lean,  watery,  unpalatable  tuber ;  a  relatively  few 
years  of  artificial  selection  made  it  a  valuable  food  product  and 
a  table  delicacy.  Compare  the  development  of  domestic  ani- 
mals in  the  last  few  years,  under  man's  conscious  guidance,  with 
their  slow  and  meager  development  in  a  state  of  nature.  Man 
has  precisely  this  power  of  consciously  modifying  the  natural 
and  artificial  elements  of  his  environment,  and  this  power 
continually  enlarges. 

So,  when  we  ask  if  economics  deals  with  natural  laws,  we 
really  ask  whether  this  being,  whose  activity  in  a  certain  line 
we  are  studying,  is  governed  by  such  laws.  If  we  mean  by 
this  to  ask  whether  his  action  is  characterized  by  absolutely 


THE  NATURE  AND   SCOPE  OF   ECONOMICS  u 

invariable  habits,  like  the  forces  of  physics,  we  must  plainly 
answer,  no.  If  man  had  no  power  of  initiative,  or,  on  the  other 
hand,  were  so  perfectly  rational  as  always  to  do  the  wisest  thing, 
there  would  be  a  regularity  in  his  action  which  might  perhaps 
form  the  basis  of  a  complicated,  but  exact,  science.  As  it  is, 
all  social  sciences  are  approximate  and  partly  descriptive. 
There  is  much  in  man's  action  which  is  exceedingly  (though  not 
perfectly)  regular,  and  hence  we  have  general,  though  appar- 
ently not  invariable,  laws.  There  is  a  part  of  his  action,  how- 
ever, that  seems  as  yet  to  be  capricious,  and  we  can  only  make 
note  of  it  till  we  have  more  knowledge. 

The  laws  of  economics  are  not  comparable  to  the  laws  of 
inanimate  nature  in  invariability,  but  they  are  of  very  general 
applicability,  and  are  wholly  in  line  with  the  action  and  intent 
of  nature,  and  are,  in  this  sense,  "  natural."  But  the  laws  of 
economics  are  not  natural  laws  in  the  sense  in  which  the  word 
is  often  used ;  namely,  laws  external  to  man  and  not  at  all  the 
product  of  man.  The  laws  of  economics  have  been  designated 
as  social  laws  to  distinguish  them  from  those  of  physical  science. 
Social  laws  describe  tendencies,  or  regularities,  which  appear 
especially  in  the  consideration  of  large  masses  of  facts.  Human 
mortality  serves  as  an  illustration.  When  and  how  a  certain 
man,  as  A.,  will  die,  is  proverbially  uncertain ;  but  when  we 
speak  of  hundreds  of  thousands  of  lives,  we  can  predict  with  such 
an  approximation  of  accuracy  that  the  vast  business  of  life 
insurance  can  be  built  upon  the  regularity  of  the  action  of  death. 

The  foregoing  discussion  enables  us  to  answer  in  a  word  the 
much-mooted  question,  "  Is  economics  a  science?  "  It  is  not 
an  exact  or  mathematical  science,  though  certain  portions  of 
the  subject  may  possibly  become  so.  It  is  an  approximate 
and  partially  descriptive  science,  like  all  sciences  dealing  with 
man,  or  even  with  life.  The  inexactness  of  the  social  sciences 
is  due  to  the  very  thing  which  gives  them  their  supreme  value, 
the  nature  of  man  and  the  greatness  of  their  subject. 

The  Relation  of  Economics  to  other  Sciences.  —  We  have 
already  referred  briefly  to  the  relations  between  economics 
and  some  of  the  other  sciences,  but  the  topic  is  one  which  re- 


12  OUTLINES  OF  ECONOMICS 

quires  fuller  treatment.  In  one  sense,  economics  may  be  said 
to  be  dependent  upon  practically  every  other  science,  since  the 
discoveries  in  every  field  of  knowledge  almost  inevitably  react 
upon  the  economic  life  of  man.  Modern  chemistry,  to  take  a 
single  example,  has  revolutionized  some  industries,  wholly 
created  others,  and,  through  the  agency  of  the  pure-food  laws, 
may  claim  most  of  the  credit  for  entirely  suppressing  others. 
From  psychology  economics  takes  the  axiomatic  principles 
upon  which  the  laws  of  value  rest;  from  physical  science  the 
lav/  of  diminishing  returns,  which  plays  a  very  important 
part  in  the  theory  of  distribution ;  and  from  mathematics  the 
methods  by  which  to  ascertain  how  insurance  may  be  safely 
supplied  against  accidents,  death,  and  loss  by  fire.  But  it  is  to 
the  sister  sciences  dealing  primarily  with  man  that  economics 
is  most  vitally  related. 

Man  has  been  busy  from  the  first  in  several  lines  of  effort. 
He  has  talked,  worshiped,  fought,  studied,  and  each  of  these 
lines  of  effort  has  developed  its  own  faculties  and  institutions. 
For  convenience  we  may  arrange  these  in  eight  groups,  as 
follows:  language,  art,  education,  religion,  family  life,  society 
life,  political  life,  economic  life.  Each  of  these  is  the  subject 
of  a  science  more  or  less  developed.  The  group  of  society  life  — 
that  is,  the  life  of  polite  society,  calls,  parties,  balls,  and  the 
like  —  has  been  studied  but  little,  and  we  know  few  of  its 
governing  principles.1  Language,  on  the  other  hand,  has  a 
science  which  has  attained  to  very  complete  development. 
The  rest  lie  scattered  between  these  extremes. 

A  peculiar  feature  of  these  activities  is  that  they  are  all  of 
them  collective  activities,  activities  which  one  man  cannot  well 
carry  on  alone.  This  is  obviously  true  of  family  and  political 
life,  language,  and  others ;  and  on  careful  examination  it  proves 
to  be  true  of  the  rest.  It  is  now  admitted,  after  many  experi- 
ments, that  art  and  even  religion  do  not  thrive  in  solitude.     It 

1  An  attempt  to  examine  scientifically  some,  at  least,  of  the  phenomena  of  polito 
society  has  been  made  by  a  learned  jurist,  the  late  Professor  Rudolph  von  Ihering, 
in  his  Zweck  im  Rethl.  Professor  Thorstein  Veblen  in  his  Theory  of  the  Leisure 
Class  gives  a  brilliant  though  half-satirical  explanation  of  social  conventions  in 
terms  of  origins  and  survivals. 


THE  NATURE  AND   SCOPE  OF   ECONOMICS  13 

would  seem  that  if  a  man  could  do  anything  by  himself,  it  would 
be  to  get  a  living ;  but  the  study  of  economic  history  impresses 
us  with  the  insignificance  of  all  such  effort  and  the  inevitable 
tendency  of  men  to  drift  together  in  their  economic  activity. 
If  it  were  possible  for  men  to  live  in  isolation,  every  one  of  the 
eight  lines  of  effort  we  have  mentioned  would  soon  dwindle 
into  insignificance  or  altogether  cease.  So  these  sciences  are 
all  of  them  social  sciences ;  and  as  the  sciences  that  deal  with 
life  are  now  grouped  together  under  the  name  biology  (science 
of  life),  so  the  social  sciences  may  be  grouped  under  the  title 
of  sociology,  or  the  science  of  society,  although  some  sociologists 
do  not  define  the  word  "  sociology  "  .in  this  broad  sense  of  an 
all-embracing  science  of  human  association. 

Economics,  then,  is  a  branch  of  sociology  thus  conceived. 
We  have  already  denned  it  as  the  science  which  treats  of  those 
social  phenomena  that  are  due  to  the  wealth-getting  and  wealth- 
using  activities  of  man.  We  may  speak  of  the  wealth-getting 
and  wealth-using  activities  in  all  their  relations  as  economic 
life  or  economy.  Accordingly,  economics  is  the  science  which 
deajs  with  the  economy  of  man.  A  useful  distinction  in  lan- 
guage is  thus  made  between  economy,  the  life  itself,  and  eco- 
nomics, the  science  dealing  with  that  life.  If  this  distinction 
could  always  be  observed,  much  confusion  would  be  avoided. 

We  have  economies  of  various  sorts:  the  economy  of  an 
individual,  of  a  family,  a  tribe,  a  city,  a  state,  or  a  nation,  and 
we  have,  correspondingly,  many  economic  units.  The  domi- 
nant unit  in  ancient  Greece,  for  example,  was  the  household, 
which  included  the  family  and  all  the  slaves  and  other  depend- 
ents. These  lived  together  and  formed  a  little  group  by  them- 
selves. The  economic  life  of  Greece  meant,  largely,  a  sum  of 
the  economic  activities  of  these  households,  each  of  which 
strove  to  be  sufficient  unto  itself.  It  is  interesting  to  know  that 
many  a  well-managed  Southern  plantation  before  the  Civil  War 
endeavored  to  produce  nearly  all  the  means  of  life  on  the  planta- 
tion, and  in  this  respect,  as  in  others,  resembled  a  Greek  house- 
hold. But  as  time  has  progressed,  these  old  groups  have 
been  partially  dissolved,  and  in  many  instances   in   modern 


14  OUTLINES  OF  ECONOMICS 

times  the  individual,  in  his  economic  activity,  constitutes  a 
unit,  although  the  family  is  still  the  prevalent  economic  unit. 
It  is  a  natural  outcome  of  economic  progress,  as  already  ex- 
plained, that  the  relations  between  these  units  have  multiplied 
indefinitely  in  number  and  in  importance.  This  is  simply 
another  way  of  describing  the  growing  interdependence  of  men. 
Economics  deals  especially  with  the  mutual  relations  of  econo- 
mies of  all  kinds,  private  and  public.  It  is  chiefly,  if  not 
exclusively,  a  science  of  human  relations,  and  without  these 
relations  could  not  exist. 

Because  of  the  organic  connection  of  these  relations  in  their 
common  origin,  man,  and  because  economics  deals  with  the 
individual  as  he  is,  and  not  with  an  artificially  simplified  "  eco- 
nomic man,"  it  is  impossible  wholly  to  dissociate  the  social 
sciences,  and  particularly  impossible  to  divorce  economics 
completely  from  ethics  and  politics.  This  does  not  mean  that 
these  sciences  are  all  one  and  cannot  be  profitably  subdivided. 
On  the  contrary,  because  of  the  limitations  of  the  human  mind, 
they  must  be  studied  separately  so  far  as  is  possible.  Scientific 
progress,  like  industrial  progress,  comes  largely  through  spe- 
cialization and  the  division  of  labor.  Man  cannot  profitably 
study  things  in  general.  What  it  does  mean  is  that  there  is 
some  territory  common  to  all  these  sciences,  and  that  occa- 
sionally the  economist  is  forced  to  pass  ethical  judgments  and 
to  decide  political  questions.  In  the  consideration  of  railway 
rates,  for  instance,  the  economist  may  be  compelled  to  pass 
judgment  upon  what  is  just  and  reasonable,  and  he  discovers 
upon  investigation  that  by  common  consent  what  is  fair  or 
reasonable  must  be  decided  largely  upon  economic  grounds. 
The  same  is  true  of  the  apportionment  of  taxes,  in  which  subject 
ethical,  legal,  and  economic  questions  are  inextricably  inter- 
woven. Commercial  policies,  restrictive  regulations,  and  sump- 
tuary laws  have  been  the  very  stuff  and  subject-matter  of  the 
science  of  economics  from  its  first  beginning.  In  analyzing 
the  progress  of  the  past  or  the  conditions  of  the  present,  we  are 
forced  to  pass  judgment  upon  the  success  or  failure  of  many 
laws  and  policies  which  are  still  in  force  or  under  active  dis- 


THE  NATURE   AND   SCOPE  OF   ECONOMICS  i$ 

cussion.  Many  of  these  must  be  indorsed  or  repudiated  either 
solely  or  largely  upon  economic  grounds ;  and  because  of  these 
facts,  the  economist  cannot,  even  if  he  would,  refrain  from  pass- 
ing judgment  upon  laws  and  political  policies.  Nevertheless, 
as  was  stated  before,  economics  does  not  undertake  the  complete 
and  systematic  study  of  law,  ethics,  and  politics,  and  its  conclu- 
sions must  almost  always  be  supplemented  by  non-economic 
considerations  which  the  economist  may  not  have  taken  into 
account. 

Principal  Divisions  of  Economics.  —  This  view  of  the  in- 
evitably practical  character  of  economic  science  is  carried  out 
in  the  treatment  of  the  subject  in  the  following  pages.  The 
history  of  the  evolution  of  economic  society,  sketched  in  Book  I, 
is  followed,  in  Book  II,  by  a  discussion  of  the  production,  con- 
sumption, exchange,  and  distribution  of  wealth.  These  sub- 
jects are  treated  in  close  connection  with  those  illustrative 
economic  problems  of  which  the  so-called  "  economic  theory," 
at  its  best,  is  but  a  more  comprehensive  and  consequently  more 
abstract  analysis.  Book  III  has  been  reserved  for  the  subject 
of  public  finance,  and  in  an  appendix  is  given  a  brief  sketch  of 
the  history  of  economic  thought. 

QUESTIONS 

i.  What  is  the  meet  essential  characteristic  of  economics?  Define  eco- 
nomics. 

2.  Is  man  or  goods  the  more  prominent  thing  in  economic  study?  Does 
economics  teach  the  student  how  to  succeed  in  business? 

3.  What  determines  ultimately  whether  a  man  is  poor  or  not?  What 
kinds  of  poverty  are  there? 

4.  What  is  meant  by  "dear  labor"?  Is  it  a  good  thing  for  society  in 
general?  for  employers  in  general ?  for  an  individual  employer? 

5 .  What  is  the  difference  between  natural  and  artificial  selection  ?  Which 
applies  to  human  society? 

6.  Are  practical  ethical  and  political  judgments  the  chief  ends  and  prod- 
ucts of  economic  science? 

7.  Is  economics  concerned  with  the  negro  question  ?  bank  notes?  prohibi- 
tion?  anti-trust  laws?   race  suicide?   protection? 

8.  What  is  a  scientific  law  ?  Contrast  with  a  statutory  law ;  with  a  moral 
law ;  with  the  laws  of  mathematics. 


1 6  OUTLINES  OF  ECONOMICS 


REFERENCES 


Cairnes,  J.  E.     The  Character  and  Logical  Method  of  Political  Economy. 

Cossa,  L.    An  Introduction  to  the  Study  of  Political  Economy. 

Dunbar,  C.  F.     "The  Academic  Study  of  Political  Economy,"  in  his 

Economic  Essays. 
Ingram,  J.  K.     A  History  of  Political  Economy.     Chap.  vii. 
Keynes,  J.  N.     The  Scope  and  Method  of  Political  Economy. 
Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Appendixes  C  and  D. 
Mill,  J.  S.     Essays  on  Some  Unsettled  Questions  of  Political  Economy. 
Sedgwick,  Henry.     The  Scope  and  Method  of  Economic  Science. 
Wagner,    Adolph.     "On    the    Present    State    of    Political    Economy," 

Quarterly  Journal  of  Economics,  Vol.  i. 


CHAPTER  II 

THE    CHARACTERISTICS    OF    THE    PRESENT 
ECONOMIC    SYSTEM 

Our  Environment.  —  Lying  back  of  all  of  our  economic  ac- 
tivity is  the  fact  that  we  live  in  an  environment  in  which  the 
things  that  we  desire  are  not  furnished  spontaneously  in  un- 
limited quantities.  Whether  it  be  looked  upon  as  due  to  the 
niggardliness  of  nature  or  to  the  insatiability  of  human  wants, 
the  fact  is  that,  for  the  most  part,  the  material  things  that  we 
use  must  be  economized.  We  must  put  forth  effort  and  exer- 
cise self-denial  in  order  to  enjoy  the  good  things  of  life.  Those 
human  arrangements  which  help  to  determine  how  much  of  ef- 
fort, of  self-denial,  and  of  enjoyment  is  to  fall  to  the  lot  of  each 
of  us  are  the  characteristics  to  which  we  now  turn  our  attention. 
There  are,  however,  a  number  of  social  institutions  which  do 
not  fall  within  the  scope  of  the  present  chapter.  We  deal  here 
only  with  the  social  conditions  directly  underlying  our  economic 
activity,  which  is  but  one  aspect  of  our  social  life.  We  must 
leave  to  the  sociologists  and  other  students  of  society  a  discus- 
sion of  such  topics  as  the  family,  religion,  morality,  ceremonial 
institutions,  and  the  nature  of  government,  although,  to  be  sure, 
these  also  have  their  effect  upon  the  economic  sphere  and  are  in 
turn  affected  by  it. 

Private  Enterprise  and  State  Activity.  —  We  live  in  an  age 
when  private  enterprise,  for  the  most  part,  is  relied  upon  to 
furnish  us  with  the  necessities  and  enjoyments  of  life.  The 
cultivation  of  the  soil,  the  exploitation  of  the  mines,  transport, 
the  various  stages  of  manufacture,  and  the  distribution  of  the 
finished  product  are  all  left  mainly 1  to  private  initiative.     The 

1  This  applies  especially  to  the  United  States  and  England  so  far  as  transport 
<s  concerned ;    it  woulfl  not  hold  true  of  every  country. 
C  17 


1 8  OUTLINES  OF  ECONOMICS 

discovery  of  new  processes,  invention,  and  experimentation  are 
carried  on  mostly  by  private  individuals  or  corporations  who 
take  upon  their  own  shoulders  the  risk  of  failure.  The  State, 
on  the  other  hand,  participates  in  this  activity  in  a  variety  of 
ways.  It  maintains  order,  promotes  the  public  health  and  safety, 
provides  roads,  and  takes  complete  charge  of  some  industries. 
In  its  educational  institutions  the  State,  through  its  agents,  un- 
dertakes various  experiments,  and  encourages  the  growth  and 
diffusion  of  knowledge,  an  indispensable  condition  of  continuous 
advancement  in  our  economic  life.  The  state  university  and  the 
experiment  farms  may  be  mentioned,  and  also  the  large  and 
extremely  useful  Department  of  Agriculture  of  the  United  States, 
with  its  annual  expenditure  of  about  twenty  million  dollars. 
Certainly  in  the  vast  majority  of  the  enterprises  with  which  we 
are  familiar,  private  and  public  activities  are  combined  in  vary- 
ing proportions. 

In  speaking  of  "State"  activity,  the  reference  is  to  organized  society 
acting  through  any  one  of  the  various  governmental  agencies,  such  as  the 
township,  city,  or  national  governments,  and  not  merely  the  political  unit 
which  we  know  in  this  country  as  the  state  government.  The  term  "govern- 
mental activity"  is  sometimes  employed  but  is  less  desirable.  The  word 
"government"  suggests  to  the  ordinary  mind  a  power  apart  from  and 
superior  to  the  people  —  a  restraining  or  punishing  power  —  whereas  the 
modern  concept  of  the  State  is  that  of  a  cooperative  institution,  main- 
tained to  safeguard  and  promote  the  general  welfare.  "Private"  activity, 
it  should  be  noted,  is  a  broader  term  than  "individual"  activity.  It 
includes  all  forms  of  joint  or  associated  action  except  those  which  consti- 
tute the  activities  of  the  State. 

Let  us  take  the  case  of  an  industry  which  is  as  nearly  private, 
perhaps,  as  any  we  can  find  —  that  of  agriculture  —  and  notice 
the  part  which  public  activities  play  in  securing  the  farmer's  re- 
sult. First,  we  may  say  that  the  farmer  owns  the  farm  that  he 
cultivates ;  this  is  private  property.  But  how  comes  it  that  the 
farm  is  his?  Why  does  not  a  stronger  man  drive  him  off  and 
take  the  farm  himself  ?  Plainly  because  the  State  protects  him 
in  the  possession  of  the  farm.  When  he  bought  the  farm,  he  took 
his  deed  to  a  government  official,  who  recorded  it,  and  thus  gave 
him  an  additional  guarantee  of  possession.    A  neighbor's  dog 


THE   PRESENT   ECONOMIC   SYSTEM  19 

kills  his  sheep,  and  an  appeal  to  the  State  compels  the  neighbor 
to  redress  the  grievance.  Another,  far  below,  dams  a  river  and 
backs  the  water  up  so  that  it  overflows  his  land.  Another  appeal 
to  the  State  removes  the  dam  or  secures  compensation.  When 
wheat  is  raised,  the  farmer  hauls  it  to  market  by  a  road  built,  not 
by  private,  but  by  public,  activity.  The  railway  lowers  the  price 
of  his  wheat  by  a  discriminating  rate,  and  again  government  in- 
terferes in  his  behalf.  But  manifold  and  important  as  are  the 
regulations  of  the  government,  State  activity  seems  very  much 
restricted  when  we  reflect  that  it  might  extend  over  the  entire 
industrial  field.  Today  the  distinctive  characteristic  of  our  eco- 
nomic life  is  private,  not  public,  enterprise. 

Division  of  Labor  and  Exchange.  —  It  is  commonly  taken  for 
granted  that  every  man  should  prepare  himself  for  some  special 
occupation,  that  one  should  plow  while  another  builds  or  sings. 
Hardly  any  civilization  seems  possible  without  some  industrial 
specialization,  but  our  own  age  is  peculiar  on  account  of  the  ex- 
tent to  which  this  has  been  carried.  The  introduction  of  machin- 
ery and  the  development  of  large-scale  production  have  split  up 
the  work  of  men  so  minutely  that  the  products  which  they  turn 
out  are  not  only  of  no  immediate  use  to  themselves  in  most  cases, 
but  they  are  also  useless  to  any  one  else  until  combined  with  the 
results  of  other  men's  labor,  often  performed  years  before  or 
afterwards.  It  is  a  long  and  complicated  process  from  the  man 
who  mines  the  ore  which  is  to  reappear  in  a  steel  plow,  to  the 
man  who  bakes  the  bread.  This  specialization  of  employment 
has  some  far-reaching  results  : 

1.  It  implies  the  exchange  of  goods.  If  we  produce  things 
we  do  not  need,  we  must  find  some  one  else  who  does  want  them 
and  some  one  who  has  the  things  we  desire.  Money,  banks,  and 
transportation  agencies  could  largely  be  dispensed  with  if  each 
family  produced  for  itself  alone.  There  would  be  none  of  the 
complex  problems  that  center  about  the  question  of  how  much 
each  of  us  is  to  receive  in  exchange  for  his  services.  One  of  the 
striking  characteristics  of  this  process  of  exchange  is  the  great 
extent  to  which  it  is  automatic.  There  is  no  government  official 
whose  business  it  is  to  discover  how  much  of  each  commodity 


20  OUTLINES  OF  ECONOMICS 

will  be  needed,  and  to  direct  that  that  amount  shall  be  produced.1 
Men  are  legally  allowed  to  engage  in  almost  any  undertaking 
that  attracts  them,  and  yet  we  take  it  for  granted  that  somehow 
things  will  get  produced  in  the  proper  proportions.  A  hundred 
men  are  set  to  work  in  a  factory  making  nothing  but  hats,  many 
more  than  they  or  their  friends  can  use,  but  the  manager  has 
faith  that  heads  will  be  found  to  wear  them  all.  Farmers  con- 
fidently proceed  to  raise  wheat,  never  troubling  themselves 
about  the  grinding  and  baking.  Neither  workmen  nor  em- 
ployers in  general  know  why  wages  are  as  they  are.  Men  lend 
money  or  goods,  now  for  one  price,  now  for  another,  but  few 
know  why  they  demand  interest  or  why  the  rate  changes. 
These  processes  go  on  visibly  before  us,  but  the  governing  laws 
are  hidden  except  to  the  careful  investigator.  In  this  respect 
they  are  like  the  laws  of  physiology.  We  eat  and  digest  our 
food,  but  how  many  people  know  how  or  why  digestion  takes 
place?  It  is  easy,  however,  to  overemphasize  this  idea,  for 
a  great  deal  of  our  economic  activity  is  conscious  and  volitional. 
When  we  decide  to  make  a  law  or  levy  a  tax,  we  do  it  consciously, 
considering  arguments,  and  finally  will  to  do  the  thing  in  ques- 
tion. And  even  in  business  undertakings  there  must  be  much 
careful  study  of  the  probable  demand  for  various  kinds  of  goods 
and  of  the  most  economical  ways  of  producing  them. 

a.  The  specialization  of  work  and  exchange  of  goods  just 
referred  to  necessarily  imply  that  mutual  dependence  briefly 
considered  in  the  preceding  chapter.  Instead  of  a  number  of 
distinct,  self-sufficient  units,  we  have  a  coherent  society  where 
one  individual  relies  upon  many  others  to  complete  his  own  one- 
sided economic  activity.  A  strike  of  street-car  employees,  or 
of  teamsters,  or  the  destruction  of  an  electric  lighting  plant, 
would  each  send  a  shock  of  inconvenience  through  a  community. 
A  prolonged  railway  strike  would  be  felt  as  a  national  misfortune. 
Indeed,  this  interdependence  is  international  in  its  scope.  Eng- 
land relies  on  other  nations  to  send  her  food  in  exchange  for  her 

1  The  government  does  help,  however,  by  collecting  and  publishing  information, 
such  as  crop  reports,  statistics  of  the  amount  of  cotton  ginned,  consular  reports 
as  to  opportunities  in  foreign  markets,  and  in  various  other  wavs. 


THE   PRESENT  ECONOMIC  SYSTEM  21 

manufactured  products,  and  many  a  German  workman  would 
be  in  distress  if  our  exports  of  cotton  or  copper  should  suddenly 
cease,  as  is  happening  in  the  great  European  War,  in  progress 
at  the  time  that  this  is  being  penned.  The  United  States  is  more 
self-sufficient  economically  than  many  other  nations,  but  we 
are  nevertheless  dependent  upon  international  trading  for  our 
supplies  of  many  things. 

Economic  Classes.  —  In  part,  also,  the  specialization  of  work 
is  responsible  for  the  division  of  society  into  classes,  but  only  in 
part.  The  differences  in  the  work  of  the  carpenter,  machinist, 
and  railway  brakeman  do  not  result  in  the  formation  of  classes 
of  a  higher  and  lower  rank.  On  the  other  hand,  the  professional 
brain  worker  enjoys  some  social  esteem  that  does  not  fall  to  the 
lot  of  the  manual  worker.  But  doubtless  the  most  important 
basis  of  social  classification  is  the  possession  of  wealth.  The 
power  to  spend  freely,  while  not  the  only  test,  is  today  the  most 
widely  recognized  test  of  social  status,  regrettable  as  this  may  be. 

Private  Property.  —  We  proceed  now  to  examine  the  founda- 
tion stones  of  this  system  of  private  enterprise.  Private  prop- 
erty is  the  most  important  of  these.  For  our  present  purpose 
we  may  define  private  property  as  the  exclusive  control  over  valu- 
able things  by  private  persons.  It  is  to  be  distinguished  from  mere 
possession.  The  possessor  has  the  use  of  the  thing  for  the  time 
being,  but  unless  he  is  at  the  same  time  the  owner,  he  is  depend- 
ent upon  the  will  of  another  for  the  use  of  it.  Ownership  implies 
the  right  of  excluding  other  persons  from  the  employment  of  a 
thing.  The  exclusive  right  must  be  recognized  and  guaranteed 
effectively  by  third  parties.  If  the  exclusive  right  of  control 
over  some  valuable  thing  is  asserted  simply  by  the  strength  of 
one's  right  arm,  the  right  of  private  property  is  not  thereby 
established.  The  exclusive  right  of  control  must  be  recognized 
by  others  and  must  be  maintained  by  them. 

Over  against  private  property  we  have  public  property,  and 
there  are  some  things,  such  as  air,  which  fall  in  neither  of  these 
categories.  The  sphere  of  private  property  at  present  includes, 
not  only  food,  clothes,  and  other  things  of  personal  use,  but  also 
the  instruments  of  production  —  land,  buildings,  and  machinery. 


2  2  OUTLINES   OF  ECONOMICS 

In  the  most  important  productive  processes  the  tools  are  in  gen- 
eral not  owned  by  the  persons  who  use  them. 

It  may  be  said  that  property  is  the  chief  seat  of  social  authority.  As 
property  carries  with  it  the  exclusive  right  to  control  things,  others  may  have 
access  to  these  things  only  on  conditions  named  by  their  owners.  If  we 
look  about  us,  we  find  men  organized  and  acting  together  under  direction 
for  purposes  of  production.  In  a  factory  we  find  an  organization  of  men 
like  that  of  an  army.  We  discover  men  moving  here  and  there  and  per- 
forming arduous  tasks  in  obedience  to  command.  If  we  examine  the  nature 
of  the  authority  which  some  thus  exercise  over  others,  we  shall  find  that  it 
resides  in  property.  The  law  of  the  land  to  some  extent  establishes  the 
authority  of  man  over  man;  but  where  one  man  obeys  another  because 
the  law  in  so  many  words  tells  him  to  do  so,  we  find  a  hundred  men  obeying 
others  because  these  others  have  the  authority  which  resides  in  exclusive 
control  over  valuable  things.  Indirectly  this  latter  sort  of  authority  rests 
back  upon  the  laws  in  so  far  as  these  are  responsible  for  the  establishment  of 
property.  But  the  chief  seat  of  authority  in  society  is  based  only  indirectly 
upon  the  government ;   it  rests  immediately  upon  private  property. 

The  right  of  private  property  is  one  so  fundamental  in  our 
modern  life  that  we  scarcely  think  of  it  as  a  creation  of  man, 
maintained  by  constant  vigilance  on  the  part  of  the  State,  and 
subject  to  human  modification.  It  seems  like  bed  rock,  an  ulti- 
mate right,  needing  no  other  justification  than  its  own  obvious- 
ness. When  a  custom  has  obtained  very  widely  and  is  deeply 
rooted  in  human  life  there  is  often  a  tendency  to  claim  it  as  a 
"  natural  right."  But  the  right  of  private  property  as  we  know 
it  now  did  not  always  exist.  It  has  not  always  been  so  extensive 
or  exclusive  as  at  present.  This  is  especially  marked  in  the  case 
of  individuals,  whose  claims  as  opposed  to  those  of  the  tribe  were 
at  first  slight  and  vague ;  but  these  claims  gradually  grew, 
especially  in  the  case  of  the  chieftain,  until  tribal  or  communal 
rights  broke  down  before  them.  The  time  was  when  a  Scottish 
clan  had  absolute  right  to  the  territory  it  occupied,  and  no  chief- 
tain, however  powerful,  could  have  abridged  that  right.  Now 
there  are  beautiful  tracts  of  country  in  Scotland  which  are  almost 
denuded  of  their  agricultural  population  because  the  owners,  the 
descendants  of  these  same  chieftains,  preferred  to  raise  game  on 
their  estates.  All  are  familiar  with  the  liberty  generally  allowed 
in  this  country  of  hunting  and  fishing  on  private  estates.     This 


THE   PRESENT   ECONOMIC   SYSTEM 


?3 


is  unheard  of  in  Europe.  Slowly,  however,  we  are  extending 
our  property  claims  to  game  and  fish,  and  the  former  leniency 
of  ownership  is  disappearing. 

But  the  modern  State  is  continually  placing  limitations  and 
restrictions  on  the  right  of  private  property.  Our  cities  regulate 
the  height  of  buildings  and  prescribe  the  material  from  which 
they  must  be  made  and  the  kind  of  plumbing  which  must  be  in- 
stalled. Restrictions  of  the  uses  to  which  land  may  be  put  are 
common,  and  no  one  can  use  his  property  in  ways  that  constitute 
a  public  "  nuisance."  The  nature  and  extent  of  these  changes 
in  private  property  must  be  controlled  by  the  State  in  the  public 
interest.  How  far  interference  with  the  right  is  justified  cannot 
be  discussed  in  general  terms  :  such  a  discussion  must  deal  with 
the  specific  problems  of  municipal  ownership,  railway  regula- 
tion, and  innumerable  others.  The  point  to  be  emphasized  here 
is  that  in  solving  such  problems  the  mere  fact  that  a  proposed 
solution  restricts  or  enlarges  the  right  of  private  property  cannot 
in  itself  be  given  much  weight. 

Trademarks,  Copyrights,  and  Patents.  —  These  are  legal 
arrangements  whereby  exclusive  privileges  are  awarded  in  return 
for  certain  services  to  society.  These  privileges  become  a  special 
form  of  private  property.  Their  justification  lies  in  the  fact 
that  they  are  a  means  of  promoting  "  the  progress  of  science  and 
useful  arts."  It  must  be  remembered,  however,  that  all  such 
progress  is  a  historical  product.  The  telephone,  for  example, 
was  preceded  by  a  century  of  scientific  invention  and  discovery, 
most  of  it  poorly  remunerated.  The  telegraph  was,  similarly, 
the  result  of  the  careful  plodding  industry  of  scores  of  men. 
Professor  Henry,  of  Princeton  College,  whose  services  in  connec- 
tion with  the  completion  of  the  telegraph  were  most  distinguished, 
conscientiously  refused  to  take  out  any  patent.  It  often  happens 
that  several  persons  almost  simultaneously  and  independently 
make  the  same  discoveries  and  inventions.  Our  patent  laws 
seem  frequently  to  reward  the  man  who  makes  the  finishing 
touches  which  lead  to  the  utilization  of  a  long  line  of  work.  But 
it  is  the  hope  of  being  the  one  who  may  give  the  practical  turn 
to  an  idea  that  lures  many  a  man  on  to  undertake  the  laborious 


24  OUTLINES  OF  ECONOMICS 

task  of  doing  the  extensive  experimentation  often  necessary  to 
place  an  article  on  the  market. 

In  order  that  patents  and  copyrights  may  not  become  the 
bases  of  burdensome  monopolies,  they  are  of  limited  duration. 
Patents  in  the  United  States  run  for  seventeen  years,  and  copy- 
rights for  a  period  of  twenty-eight  years.  Copyrights  may  be 
renewed  for  another  term  of  the  same  length.  These  legal  privi- 
leges have  resulted  in  an  enormous  amount  of  litigation  and  have 
given  rise  to  special  problems.  One  of  these  is  the  question  of  the 
extent  to  which  the  manufacturer  of  a  patented  article  should 
have  the  right  to  control  the  price  after  the  article  has  left  his 
hands.  It  is  frequently  asserted  that  owners  of  patents  should 
be  compelled  to  permit  other  persons  to  use  them  upon  the  pay- 
ment of  royalty,  so  as  to  promote  competition  in  manufacture. 
But  there  is  some  danger  that  such  legislation  would  defeat  the 
primary  object  of  the  patent  system.  Even  with  the  exclusive 
right  to  manufacture  an  article  it  frequently  requires  a  long 
struggle  to  make  an  invention  a  commercial  success.  It  has  also 
been  suggested  that  the  United  States  government  should  re- 
serve the  right  to  purchase  a  patent,  but  it  is  improbable  that 
this  right,  if  reserved,  would  be  often  exercised. 

Inheritance.  —  Inheritance  is  often  regarded  as  a  necessary 
part  of  the  right  of  private  property,  and  it  is  true  that  the  entire 
abolition  of  the  right  of  inheritance  would  result  in  a  great  en- 
largement of  public  property  at  the  expense  of  private  property, 
unless  gifts  were  used  to  replace  inheritance  as  a  means  of  trans- 
ferring property  from  one  generation  to  the  next.  But,  in 
truth,  property  and  inheritance  are  two  distinct  rights.  Private 
property  is  an  exclusive  right  of  control,  whereas  inheritance  is 
the  transmission  of  this  right  from  one  generation  to  another. 

As  in  the  case  of  private  property  itself,  the  right  of  inheritance 
is  not  recognized  today  as  absolute.  Detailed  regulations  exist 
on  our  statute  books  regarding  the  making  of  wills  and  regulating 
the  descent  of  property  where  no  will  is  made,  and  there  is  an 
increasing  tendency  to  limit  the  right  of  inheritance  by  taxation. 
That  which  seems  a  mere  natural  right  at  one  time  seems  a  wrong 
at  another,  as  is  illustrated  in  the  changing  ideas  and  practices 


THE   PRESENT   ECONOMIC   SYSTEM 


25 


concerning  the  share  of  a  father's  estate  to  be  inherited  by  the 
oldest  son. 

Contract.  —  Hardly  second  in  importance  to  the  right  of  pri- 
vate property  is  the  right  of  contract,  for  the  maintenance  of 
which  we  are  equally  dependent  on  the  State.  Some  sort  of 
contract  lies  at  the  basis  of  all  associated  activity.  To  secure  the 
condition  of  such  activity,  it  is  necessary,  first,  that  men  should 
be  allowed  to  bind  themselves ;  and,  second,  that  they  should 
be  compelled  to  abide  by  the  agreement  thus  entered  into.  The 
entrance  into  a  valid  contract  is  ordinarily  voluntary,  but  once 
entered  into  with  due  formality,  the  State  will  use  its  superior 
power  to  enforce  it.  To  the  anarchist  this  seems  oppressive,  and 
it  is  true  that  a  state  of  society  is  conceivable  in  which  the  ele- 
ment of  force  might  be  removed  from  the  idea  of  contract,  but 
something  else  would  have  to  be  substituted  to  make  the  keeping 
of  agreements  the  general  rule.  There  are  doubtless  many 
people  living  today  with  whom  the  feeling  of  honor  or  the  fear 
of  social  disapprobation  would  be  sufficient  for  the  enforcement 
of  contracts,  just  as  these  persons  might  not  need  the  threat  of 
a  jail  sentence  to  keep  them  from  stealing. 

The  economic  ties  which  hold  men  together  in  industrial  society  are,  on 
their  legal  side,  very  generally  contracts.  The  organization  of  an  industrial 
corporation  implies  many  contracts.  Our  property  is  acquired  very  largely 
through  contract,  and  through  contract  we  determine  the  conditions  under 
which  we  do  our  work,  such  as  the  length  of  the  working  day.  The  continu- 
ity of  our  economic  life  rests  upon  contracts,  which  bind  together  past, 
present,  and  future.  Still,  all  that  we  have  by  no  means  comes  to  us  through 
contract.  "  Contract "  does  not  exhaust  the  significance  of  parentage,  home, 
and  education,  and  much  wealth  changes  hands  through  gifts  and  inheritance. 

Laws  are  frequently  enacted  regulating  contract  in  the  general 
interest.  This  is  especially  marked  in  labor  legislation,  which 
will  be  discussed  in  another  chapter.  Certain  contracts  cannot 
be  enforced  by  law,  because  they  are  held  to  be  against  public- 
policy,  as,  for  example,  gambling  contracts  and  contracts  in 
restraint  of  trade.  In  some  cases  statutes  make  it  illegal  to 
enter  into  such  contracts. 

Vested  Interests.  —  A  few  words  should  be  said  about  vested 


26  OUTLINES  OF  ECONOMICS 

interests.1  Vested  interests  are  legally  recognized  pecuniary- 
interests  which  cannot  be  impaired  by  public  action  without 
indemnification.  Vested  interests  generally  arise  through  prop- 
erty and  contract.  Outside  of  property  and  contract,  however, 
there  may  be  vested  interests.  Leeds  was  compelled  by  a  feudal 
arrangement  to  grind  its  corn,  grain,  and  meal  at  the  lord's  mill 
till  well  on  in  the  last  century,  and  finally  had  to  pay  £  13,000  to 
terminate  this  obligation.  When  Prussia  bought  the  railways, 
the  railway  presidents  were  indemnified  for  the  loss  of  their  posi- 
tions by  large  payments ;  in  other  words,  their  offices  were  looked 
upon  as  vested  interests.  England  is  the  classic  land  of  vested 
interests.  An  office  in  the  army  was  until  recently  looked  upon 
as  such,  and  so  was  an  appointment  in  the  established  church. 
It  is  generally  held  that  keepers  of  public  houses  in  England  li- 
censed to  sell  beer  and  spirits  have  a  vested  interest  in  their  busi- 
ness, so  that  they  must  be  indemnified  if  their  licenses  are  taken 
from  them.  Workingmen  have  frequently  claimed  that  they 
have  a  vested  interest  in  the  advantages  which  their  skill  in  their 
trades  gives  them,  and  that  if  through  industrial  changes  this 
skill  ceases  to  be  of  as  great  value  as  formerly,  they  ought  to  be 
indemnified  and  in  some  way  their  former  income  continued. 
This  claim  of  the  workingmen,  however,  unlike  many  other 
claims  put  forward  in  the  name  of  vested  interests,  has  not  re- 
ceived recognition,  either  by  Parliament  or  the  courts.  Vested 
interests,  apart  from  property  and  contract,  are  of  less  signifi- 
cance in  the  United  States  than  in  most  countries,  but  they 
may  become  of  more  significance  in  the  future. 

Freedom.  —  The  freedom  to  do  certain  things  is  legally 
guaranteed  at  the  present  time,  such  as  moving  from  one  part  of 
the  country  to  another,  choosing  one's  own  occupation,  and 
acquiring  property.  These,  together  with  the  absence  of  slavery 
and  of  imprisonment  for  debt,  are  characteristic  features  of  the 
present  economic  order  as  distinguished  from  past  conditions. 
The  right  to  manufacture  and  sell  what  and  when  one  pleases  is 
also  comparatively  recent.  It  has  often  been  greatly  limited  by 
despotic  governments,  and  has  been  made  a  matter  of  sale  for 

•The  term  "vested  rights"  is  also  used. 


THE  PRESENT  ECONOMIC   SYSTEM 


27 


the  purpose  of  raising  revenue.  Such  limitations  gave  rise  to 
many  abuses,  and  our  own  time  has  seen  the  abolition  of  an  im- 
mense number  of  hampering  and  vexatious  restrictions  often 
designed  for  extortion  rather  than  for  the  promotion  of  private 
enterprise.  So  far  as  the  absence  of  legal  restrictions  on  the 
actions  of  individuals  is  concerned,  the  past  century  has  been 
distinctively  an  age  of  economic  freedom. 

Restrictive  laws,  however,  are  not  the  only  limitations  on  eco- 
nomic freedom.  The  system  of  private  property  itself  means 
that  certain  individuals  in  the  community  have  power  to  com- 
mand other  people  to  work,  and  the  lack  of  an  income  under  our 
present  regime  implies  the  lack  of  the  real  freedom  to  do  things. 
The  cost  of  a  railway  ticket  may  be  quite  as  effective  as  a  legal 
barrier  would  be  in  preventing  movement  from  one  state  to  an- 
other. We  say  involuntary  servitude,  except  as  punishment  for 
crime,  has  been  abolished,  yet  men  are  compelled  to  work  by 
the  threat  of  economic  distress,  in  most  cases  quite  as  effectively 
as  by  means  of  the  slave-driver's  whip.  Again,  the  choice  of  an 
occupation  is  free  according  to  the  law,  but  we  may  find  that  a 
long  and  expensive  course  of  training  is  necessary,  or  trades- 
unions  effectively  limit  the  number  who  can  learn  a  given  trade. 
The  right  to  establish  enterprises  is  granted  to  all  alike  according 
to  the  law,  but  today  most  persons  would  find  it  difficult  and 
hazardous  to  embark  upon  the  refining  of  oil  or  the  manufac- 
ture of  steel.  For  most  men,  the  freedom  to  establish  new  en- 
terprises has  been  growing  less  and  less  in  this  era  of  large-scale 
production. 

This  leads  us  to  a  distinction  between  what  have  been  called 
negative  freedom  and  positive  freedom.  Mere  absence  of  re- 
straint (negative  freedom)  is  one  thing,  and  the  power  to  develop 
our  activities  to  the  fullest  extent  (positive  freedom)  is  a  very 
different  thing.  Legal  restrictions  may  actually  be  the  means 
of  increasing  positive  freedom.  Thus,  a  library  placed  at  the 
disposal  of  the  public  without  rule  or  regulation  would  result  in 
a  smaller  total  utilization  of  the  books  than  one  in  which  the  ob- 
servance of  certain  rules  is  strictly  enforced.  All  laws  which 
limit  the  power  of  the  strong  to  oppress  and  which  help  to  open 


28  OUTLINES  OF  ECONOMICS 

the  gates  of  opportunity  to  all  must  of  necessity  increase  positive 
freedom.  The  newer  idea  of  freedom  aims  at  the  development 
of  such  social  arrangements  that  sane  and  complete  lives  will  be 
possible  for  the  largest  number  of  persons. 

Competition  and  Markets.  —  As  a  result  of  the  legal  conditions 
that  have  been  mentioned,  we  find  men  engaged  in  many  kinds 
of  rivalry.  Our  economic  society  is  often  called  "  competitive  " 
for  this  reason.  But  this  term  does  not  apply  to  all  forms  of 
rivalry,  for  economic  competition  is  based  on  private  property  and 
free  contract.  There  might  still  be  conflicts  between  races  and 
nations  if  private  property  and  free  contract  were  abolished. 
The  men  of  any  single  nation  might  still  vie  with  one  another  to 
prove  their  superiority  in  the  eyes  of  womankind  or  to  gain  posi- 
tions of  public  honor  and  power.  The  kind  of  competition  which 
is  distinctive  of  the  present  economic  order  is  the  all-pervading 
endeavor  to  obtain  the  largest  possible  amount  of  wealth  in  ex- 
change for  commodities  produced  or  services  rendered.  If  we 
except  the  idlers,  the  parasites,  and  the  cheats,  men  are  every- 
where endeavoring  to  discover  what  other  people  urgently 
want,  and  then  to  satisfy  these  wants  in  the  most  efficient  manner 
possible.  Moreover,  they  attempt  to  give  as  little  as  possible 
of  their  own  products  in  exchange  for  the  things  they  themselves 
desire.  Business  competition  thus  has  two  sides:  rivalry  in 
rendering  a  service,  and  alertness  in  exacting  a  return.  Each 
individual  takes  part  in  the  competitive  contest  in  two  ways: 
first,  as  a  seller  of  goods  or  services,  in  which  case  he  finds  that 
others  are  anxious  to  render  the  same  service ;  and  second,  as  a 
buyer  of  the  things  he  wants,  in  which  case  he  finds  that  these 
same  things  are  sought  by  other  people. 

The  intensity  of  the  competitive  struggle  is  subject  to  a  good 
deal  of  variation.  At  times  it  may  be  characterized  as  cut- 
throat, where  the  slashing  of  prices  has  for  its  object  the  elimina- 
tion of  one  or  more  of  the  contestants.  But  in  most  lines  of 
endeavor  many  competitors  may  continue  to  exist  side  by  side 
indefinitely,  each  being  confronted  by  the  ever  present  threat 
that,  if  his  service  becomes  very  poor,  some  other  man  will  our- 
strip  him.     Various  as  may  be  the  character  of  competition,  now 


THE  PRESENT  ECONOMIC   SYSTEM 


29 


predatory,  now  a  friendly  rivalry,  there  is  no  resting  place  in  the 
contest  unless  one  secures  some  special  privilege  as  a  shelter. 
He  who  is  energetic,  and  wins  success  in  a  certain  line  of  business, 
must  continue  to  defend  himself  from  a  host  of  imitators  who  are 
anxious  to  snatch  his  gains  from  him.  Most  of  the  competitors 
are  successful  in  getting  something,  some  more  than  others,  but 
many  fail  altogether.  These  last,  the  inefficient,  whether  made 
so  by  sickness,  by  inherited  weakness,  or  by  lack  of  proper  train- 
ing, fall  by  the  wayside  and  must  be  cared  for  by  private  charity 
or  by  the  State.  The  process  is  cruel  in  many  of  its  details,  but 
there  is  also  a  beneficent  aspect  in  its  sifting  out  of  the  incompe- 
tent and  in  its  encouragement  of  the  strong. 

Here,  again,  the  automatic  character  of  the  present  industrial 
system  manifests  itself.  It  is  through  competition  and  bargain- 
ing in  the  market  that  the  prices  of  goods  and  services  are  fixed, 
and  it  is  to  the  variations  in  these  prices  that  men  look  for  indi- 
cations as  to  what  people  want.  Price  is  the  universal  barometer 
that  indicates  changes  in  the  demand  for  goods  of  all  kinds. 

Fair  Competition.  —  Competition  has  been  spoken  of  as  a 
struggle,  a  contest,  accompanied  by  success  and  failure,  elation 
and  disappointment.  But  the  State  sets  limits  to  the  rivalry, — 
it  makes  regulations  and  acts  as  an  umpire  to  compel  fair  play. 
It  attempts  to  eliminate  fraud  and  brute  force ;  it  trains  the  ris- 
ing generations  for  an  entrance  into  the  struggle  by  a  system  of 
free  education ;  it  insists  that  no  person  shall  sacrifice  the  life 
and  limb  of  another  in  the  rush  for  wealth ;  and  it  protects  chil- 
dren and  women  when  they  seem  compelled  to  labor  under  un- 
heal thful  conditions.  Those  who  fail  entirely  in  the  struggle  it 
tries  to  rescue  from  suffering.  Libelous  and  fraudulent  state- 
ments about  a  competitor's  business  are  illegal.  So  are  efforts  to 
induce  his  customers  or  employees  to  break  their  contracts  with 
him.  Competition  designed  to  drive  a  rival  out  of  business  is 
illegal,  whatever  its  methods,  if  it  is  prompted  by  sheer  malice  or 
is  part  of  an  effort  to  establish  a  monopoly.  The  Federal  Trade 
Commission,  established  in  19 14,  is  empowered  to  issue  orders 
restraining  the  use  of  unfair  methods  of  competition  by  persons 
engaged  in  interstate  commerce.     In   short,  the  State  aims  to 


30  OUTLINES  OF  ECONOMICS 

raise  the  plane  or  ethical  level  of  competition,  changing  it  from 
brutal  warfare  into  a  contest  in  which  there  are  prizes  for  all,  but 
in  which  the  prizes  are  graded  according  to  the  energy  and  ability 
of  the  contestants. 

Cooperation.  - —  The  statement  that  our  age  is  one  of  competi- 
tion is  misleading  if  it  gives  the  impression  that  every  individual 
is  always  struggling  against  all  of  his  fellows.  On  the  con- 
trary, the  achievements  of  modern  industrial  civilization  would 
be  impossible  without  a  far-reaching  cooperation  between  in- 
dividuals. Employers  and  employees  may  quarrel  and  bargain 
about  the  wage  contract,  but  when  they  have  settled  their  rela- 
tions for  a  week  or  a  year,  they  become  cooperators  for  that 
period  in  the  conduct  of  the  business  enterprise  in  which  they  are 
engaged.  Again,  there  is  an  unconscious  cooperation  between 
those  who  work  upon  a  commodity  in  the  different  stages  of  the 
process  from  raw  material  to  finished  product.  The  division  of 
labor  itself  is  cooperation  on  a  splendid  scale.  Competition 
merely  determines  the  conditions  on  which  the  cooperation  takes 
place.  If  these  conditions  could  be  determined  in  some  other 
manner,  it  would  be  possible  to  conceive  of  the  elimination  of 
competition  from  our  industrial  system,  but  cooperation  itself 
is  so  vital  and  fundamental  that  its  elimination  would  mean  a 
return  to  barbarism. 

Monopoly.  —  Everywhere  in  the  industrial  field  the  tendency 
toward  monopoly  is  present.  Business  men  endeavor  so  far  as 
possible  to  shelter  themselves  from  the  effects  of  the  competitive 
struggle  by  means  of  some  privilege,  but  if  none  is  to  be  found, 
and  if  competition  becomes  very  keen,  they  endeavor  to  combine 
with  other  business  men.  But  while  this  attempt  to  escape  com- 
petition is  universal,  it  is  only  under  certain  conditions,  not  gen- 
erally present,  that  it  is  at  all  likely  to  succeed.  The  possibility 
of  success  is  least  in  agriculture  and  in  mercantile  business,  where 
new  enterprises  are  started  rather  easily  because  no  special  privi- 
leges stand  in  the  way  and  because  no  very  large  capital  is  re- 
quired to  work  efficiently.  It  is  greatest  in  mining  and  trans- 
portation, where  special  privileges  are  present  and  where  large 
fixed  capital  is  required.     Scarcely  anywhere  is  it  possible  wholh 


THE  PRESENT  ECONOMIC   SYSTEM  31 

to  escape  competition,  and  we  are  still  warranted  in  speaking  of 
the  present  era  as  a  competitive  rather  than  a  monopolistic  age. 

Side  by  side  with  the  growth  of  monopoly  there  is  an  increase 
in  government  control  of  industry.  The  desire  of  the  business 
man  is  to  be  uncontrolled,  but  wherever  he  succeeds  in  throw- 
ing off  the  control  exercised  by  his  competitors,  he  inevitably 
substitutes  that  of  the  government. 

Custom.  —  Custom  plays  an  important  part  in  our  economic 
activity  as  well  as  in  every  other  department  of  social  life,  al- 
though its  sway  is  not  so  marked  as  in  former  ages  or  among 
primitive  peoples.  The  custom  of  giving  gratuities,  or  tips,  to 
servants  is  in  many  places  so  strong  as  to  have  almost  the  force 
of  law.  Again,  today  much  of  our  personal  expenditure  is  con- 
trolled by  what  custom  has  declared  to  be  proper  rather  than  by 
any  act  of  our  own  individual  reason.  Any  attempt  to  lower 
wages  which  would  make  impossible  the  maintenance  of  a  cus- 
tomary standard  of  living  would  be  stubbornly  resisted.  Ana 
as  we  shall  see  in  a  later  chapter,  the  ''  good- will  "  of  a  business, 
which  is  often  a  durable  source  of  business  profits,  is  built  up, 
in  large  measure,  on  its  ability  to  get  people  into  the  habit  or 
custom  of  trading  with  it.  Custom  is  the  result  of  habit,  and  is 
continually  broken  into  by  our  tendency  to  imitate  a  leader  who 
proposes  a  new  line  of  action.  While  custom  may  have  its  benefi- 
cent aspect  in  preventing  hasty  and  impulsive  changes,  it  fre- 
quently retards  progress  and  causes  our  legislation  and  judicial 
decisions  to  lag  behind  industrial  development. 

QUESTIONS   AND   EXERCISES 

1.  Give  further  illustrations  of  the  difference  between  positive  and  nega- 
tive freedom. 

2.  Describe  the  property  relations  existing  in  the  Amana  Society,  or  in 
other  communistic  groups. 

3.  What  regulations  concerning  the  inheritance  of  property  are  in  force 
in  your  state  ? 

4.  To  what  extent  are  gambling  contracts  valid?  Why  does  the  law 
differentiate  them  from  ordinary  business  contracts? 

5.  Compare  the  legal  freedom  of  workingmen  today  with  the  conditions 
described  in  the  Wealth  of  Nations,  Book  i,  Chap,  x,  Part  ii. 


32  OUTLINES  OF  ECONOMICS 

6.  Compare  the  rights  of  patentees  in  Bauer  v.  O'Donnell,  229  U.  S.  x 
(191 2),  with  those  allowed  in  Henry  v.  Dick  Co.,  224  U.  S.  1  (191 1). 

7.  What  do  you  regard  as  "  unfair  "  advertising ?     Give  examples. 

REFERENCES 

Bliss,  W.  D.  P.    Encyclopedia  of  Social  Reform  (new  ed.),  article  on  Amana 

Community.    See  also  on  same  subject,  Ely,  R.  T.,  in  Harper's  Monthly 

Magazine,  October,  1902. 
Ely,  R.  T.     Property  and  Contract,  in  tl.eir  Relations  to  the  Distribution  of 

Wealth,  Vol.  i,  pp.  94  and  ff. ;  Vol.  ii,  pp.  755-821. 
Green,  T.  H.     "Liberal  Legislation  and  Freedom  of  Contract,"  in  his 

Works  (edited  by  Nettleship),  Vol.  iii. 
Lewinski,  J.  S.     The  Origin  of  Property. 
Mill,  J.  S.     On  Liberty,  Chap.  iv. 

Mill,  J.  S.    Principles  of  Political  Economy,  Book  ii,  Chaps,  i.  and  ii. 
Nicholson,  J.  Shield.     Principles  of  Political  Economy,  Vol.  i,  Book  ii, 

Chaps,  ii-viii. 
Reports  of  the  United  States  Commissioner  of  Patents. 
Rogers,  E.  S.    Good  Will,  Trade  Marks,  and  Unfair  Trading. 
Sidgwick,  Henry.    Principles  of  Political  Economy,  Book  ii,  Chap.  xii. 
Stephens,  J.  F.    Liberty,  Equality,  and  Fraternity. 

Webb,  Sidney  and  Beatrice.    Industrial  Democracy,  Vol.  ii,  pp.  562-572 
Wyman,  Bruce.     The  Control  of  the  Market. 


CHAPTER  III 
THE  EVOLUTION   OF  ECONOMIC   SOCIETY 

The  evolution  of  economic  society  is  but  one  of  many  points 
of  view  from  which  the  development  of  mankind  may  be  consid- 
ered. The  history  of  literature,  the  history  of  government,  the 
history  of  religion,  each  treats  of  man  in  one  line  of  his  activities. 
Many  thinkers  have  considered  the  economic  activities  of  man- 
kind as  the  one  fundamental  factor  in  social  progress,  deter- 
mining in  the  long  run  even  our  moral  and  religious  ideas. 
But  human  life  is  complex,  and  it  is  improbable  that  any  simple 
explanation  suffices  for  all  of  its  aspects.  The  economic  factor, 
however,  is  clearly  of  fundamental  importance  in  the  sense  that 
the  higher  things  in  life  cannot  be  gained  if  man's  entire  time 
is  spent  in  getting  a  mere  subsistence,  so  that  economic  progress, 
or  increasing  control  over  the  forces  of  nature,  must  accompany 
general  social  advancement,  at  least  for  the  mass  of  the  commu- 
nity. Under  primitive  methods  of  production,  only  a  select  few 
can  have  the  leisure  which  is  a  necessary  condition  of  a  high  stand- 
ard of  living.  The  greater  the  total  social  product,  the  better 
the  possible  satisfaction  of  the  true  economic  wants  of  all ; 
and,  other  things  being  equal,  the  more  satisfactory  the  founda- 
tion on  which  to  rear  a  high  democratic  civilization. 

The  Economic  Stages.  —  Many  attempts  have  been  made  to 
divide  economic  history  into  different  stages  through  which 
mankind  passed  in  arriving  at  modern  industrial  civilization. 
These  attempts  have  been  the  subject  of  lively  criticism,  but 
it  appears  that  the  classification  which  in  the  past  has  been 
most  widely  used  is  still,  with  some  modifications,  the  most 
serviceable,  and  in  the  main,  this  will  be  followed  in  the  present 
chapter. 

The  basis  of  this  classification  is  the  increasing  power  of  man 
d  33 


34  OUTLINES  OF  ECONOMICS 

over  nature.  This  is  the  fundamental  fact  in  man's  economic 
development,  and  his  position  in  the  scale  of  economic  civiliza- 
tion is  higher  in  proportion  as  this  power  over  nature  increases. 
Increasing  control  of  nature  is  accompanied  by  changes  in  man 
himself,  especially  by  a  growth  and  diversification  of  his  wants, 
so  that  we  may  say  that  economic  civilization  consists  largely  in 
wanting  many  things  and  in  learning  how  to  make  and  use  them. 
From  this  standpoint  economic  history  may  be  divided  into  the 
following  stages :  (I)  Direct  Appropriation ;  (II)  The  Pastoral 
Stage;  (III)  The  Agricultural  Stage;  (IV)  The  Handicraft 
Stage;   (V)  The  Industrial  Stage. 

I.  Direct  Appropriation 

Primitive  man  depends  upon  finding  things,  not  upon  making 
them.  This  does  not  mean  that  the  lowest  examples  of  man- 
kind that  we  know  do  absolutely  nothing  in  the  way  of  trans- 
forming the  materials  of  nature  for  use.  The  lowest  types  know 
the  use  of  fire  and  have  rude  tools,  but,  nevertheless,  the  farther 
back  we  go,  the  more  complete  do  we  find  the  reliance  on  nature. 
One  cannot  read  descriptions  of  the  Negritos,  Veddahs,  Fuegians, 
or  native  Australians  without  being  impressed  with  the  simi- 
larity between  the  economy  of  these  peoples  and  that  of  the 
lower  animals.  But  there  are  many  tribes  commonly  regarded 
as  savages  that  show  a  great  advancement  over  those  that 
have  been  mentioned.  Among  the  North  American  Indians, 
for  example,  we  find  a  rude  sort  of  cultivation  of  the  soil  along 
with  hunting  and  fishing.  Such  soil  cultivation  has  been  termed 
"  hoe-culture,"  and  is  to  be  distinguished  from  agriculture  with 
the  aid  of  domesticated  animals  found  in  a  later  stage  of  devel- 
opment. 

This  kind  of  agriculture  is  found  in  its  highest  state  of  development  among 
the  Negroes  of  Africa.  "The  ground  for  cultivation,"  says  Ratzel,  "is  cleared 
by  means  of  fire,  or  with  the  hatchet  or  small  ax.  On  the  east  coast  a  broad 
chopper  with  a  spear-shaped  blade  and  short  handle  is  also  used.  The 
lance  or  spearhead  has,  in  general,  to  serve  many  peaceful  purposes.  Larger 
trees  arc  killed  by  barking.  Thorny  branches  are  placed  as  a  border  to  the 
fields,  under  the  shelter  of  which  close,  thick  hedges  gradually  grow  up.    The 


THE  EVOLUTION  OF   ECONOMIC   SOCIETY  35 

ground  is  broken  and  cleared  of  weeds  with  a  wooden  spade  sharpened  to  an 
edge  at  either  end.  Many  peoples  have  hitherto  not  ventured  to  use  iron 
tools,  since  they  keep  away  the  rain.  When  the  ground  has  been  got  ready, 
somewhere  about  the  beginning  of  the  rainy  season,  the  sower  walks  over 
the  field,  scraping  a  hole  with  his  naked  foot  at  every  step,  into  which  he  lets 
some  grains  fall  from  his  hand ;  the  foot  covers  them  up,  and  if  the  good 
witch  doctor  makes  rain  enough,  and  the  bad  one  does  not  keep  it  back,  there 
is  nothing  more  to  be  done  until  harvest,  unless  to  hoe  the  weeds  once.  .  .  . 
To  the  present  day  the  plow  is  practically  strange  to  them."  1 

The  following  characterization  of  the  economy  of  primitive 
man  applies  with  varying  accuracy  to  the  many  tribes  that  may 
be  placed  in  this  first  stage. 

Characteristics  of  Primitive  Man.  —  The  range  of  wants  is 
narrow:  the  savage  is  generally  satisfied  if  he  obtains  mere 
subsistence  of  the  rudest  sort.  In  the  satisfaction  of  these 
few  wants  he  is,  according  to  our  modern  standards,  remark- 
ably inefficient.  From  even  the  best  natural  resources  he 
manages  to  get  but  a  very  poor  living,  depending  as  he  does 
largely  on  the  spontaneous  products  of  nature.  Magic  and 
ritual  are  very  generally  relied  upon  as  aids  to  wealth  produc- 
tion. He  is  improvident,  for  he  does  not  feel  keenly  the  un- 
certainties of  the  future,  and  fails  to  make  provision  for  them. 
Hence  he  has  alternate  periods  of  starvation  and  plenty. 
Only  a  small  population  is  possible  in  this  stage,  as  a  tribe 
must  have  a  large  expanse  of  territory  from  which  to  draw  its 
sustenance.  The  place  of  abode  is  easily  changed,  and  warfare 
with  neighboring  tribes  frequent.  Private  property  in  land  is 
absent,  although  the  beginning  of  the  institution  of  ownership 
appears  in  the  recognition  of  the  individual's  right  to  articles 
of  personal  use.  There  is  little  division  of  labor.  What  one 
man  can  do,  all  can  do.  The  cultivation  of  the  soil  by  the 
women  and  the  specialized  work  of  the  medicine  man  are  ex- 
ceptions. As  each  tribe  produces  or  finds  for  itself  all  that  it 
uses  there  is  little  or  no  trade.  The  beginnings  of  slavery  are 
found,  but  this  institution  plays  no  important  part  in  the 
economy  of  primitive  man,  except  among  the  most  advanced 
tribes. 

'Ratzel,  History  0/  Mankind,  trans,  by  A.  J.  Butler,  vol.  ii,  pp.  380-382. 


36  OUTLINES  OF  ECONOMICS 

II.  The  Pastoral  Stage 

In  the  older  accounts  of  economic  evolution,  the  impression  is 
given  that  hunting  peoples  learned  to  domesticate  animals  and 
then  led  a  pastoral  life,  later  learning  to  subdue  the  vegetable 
kingdom,  thus  becoming  agriculturalists.  This  is  not  alto- 
gether accurate.  It  is  possible  that  the  domestication  of 
animals  was  developed  in  regions  where  considerable  progress 
had  been  made  in  hoe-culture.  As  this  knowledge  spread, 
certain  tribes  became  and  remained  pastoral  nomads  in  regions 
where  agriculture  was  impossible.  But  whatever  the  actual 
steps  may  have  been,  the  pastoral  peoples  represent  a  type  of 
culture  that  is  lower  than  that  of  the  agricultural  stage  (as 
distinguished  from  hoe-culture),  and  higher  than  that  of  the 
hunter.  Within  this  stage  also  are  classed  together  tribes 
of  varying  advancement.  Illustrations  of  existing  pastoral  life 
are  found  in  the  tribes  of  central  Asia,  many  of  the  Arabian 
and  African  tribes,  and  the  Todas  of  India.  Attempts  have 
been  made  to  trace  the  pastoral  stage  in  the  early  history  of 
the  Hebrews,  Germans,  Greeks,  and  Britons. 

Characteristics  of  Pastoral  Peoples.  —  Some  marked  features 
of  the  first  stage  are  found  also  among  pastoral  peoples.  A 
fixed  abode  is  not  possible,  as  food  must  be  found  for  the  herds 
and  flocks.  Cities  do  not  develop.  Moreover,  while  the  land 
will  now  support  many  more  inhabitants  per  square  mile  than 
before,  much  land  is  still  needed  for  pasture,  and  there  is  frequent 
collision  and  warfare  between  neighboring  tribes.  It  follows 
also  that  there  is  very  little  private  ownership  of  land  among 
these  peoples.  Tribes  as  a  whole  lay  claim  to  certain  districts 
and  try  to  keep  other  tribes  from  pasturing  their  flocks  on 
them.  In  this  stage  there  are  frequently  individual  accumula- 
tions of  wealth,  consisting  mostly  of  herds  or  flocks,  and  thus 
the  contrast  between  rich  and  poor  makes  its  appearance.  Cus- 
tomary rules  regarding  the  inheritance  of  wealth  are  recognized. 
But  this  early  wealth  does  not  produce  commerce  to  any  con- 
siderable extent,  simply  because  there  is  little  division  of  labor 
either  between  localities  or  within  the  tribe. 


THE   EVOLUTION  OF   ECONOMIC   SOCIETY  37 

III.  The  Agricultural  Stage 

In  this  stage  there  is  an  enormous  increase  in  man's  power 
over  nature.  The  production  of  wealth  is  increased  especially 
by  the  use  of  animal  power  in  cultivating  the  soil.  One  result 
is  increased  population.  Land  which  under  the  more  primitive 
methods  of  getting  a  living  would  give  a  scanty  support  to  a 
small  tribe  for  a  part  of  the  year  will  now  maintain  a  whole 
community  with  a  fixed  abode.  It  is  necessary  for  human 
development  that  men  should  live  in  definite  places  and  have 
homes  and  a  country.  This  results  in  new  relations  between 
men,  new  duties,  new  arts,  and  new  possibilities.  The  beginning 
of  the  institution  of  private  ownership  in  land  fafls  within  this 
stage,  although  it  is  difficult  to  trace  the  actual  steps  in  the 
process. 

A  most  important  characteristic  of  this  period  is  slavery. 
Slavery  begins  long  before  improved  agriculture,  but  it  now 
attains  its  full  magnitude  as  an  institution.  Slavery  occupies 
a  prominent  place  in  the  history  of  Greece  and  Rome,  and  in 
the  Middle  Ages  develops  into  serfdom. 

Commercial  intercourse  is  still  comparatively  slight  in  this 
stage.  Fixed  residence  develops  village  communities,  and 
these  are  economically  self-sufficient.  That  is,  they  produce 
the  things  that  they  consume,  and  do  not  as  a  rule  have  surplus 
products  to  dispose  of  to  others.  Hence  money  does  not  at 
this  time  play  an  important  part  in  the  every-day  life.  The 
economic  condition  of  Europe  during  the  Middle  Ages,  before 
the  growth  of  cities,  illustrates  the  agricultural  stage. 

The  Manorial  Economy  in  England.  —  England  was  almost 
wholly  agricultural  for  three  centuries  following  the  Norman 
Conquest.  In  the  thirteenth  century  the  population  for  the 
most  part  lived  in  villages  or  manors,  each  controlled  by  a 
lord  to  whom  the  rest  of  the  inhabitants  were  bound  by  custom- 
ary rules  to  render  certain  assistance,  as  in  the  cultivation 
of  his  land.  The  villagers  were  of  various  classes,  according 
to  the  amount  of  land  which  they  held  and  according  to  the 
services  which  they  were  required  to  perform.     The  land  of 


38  OUTLINES  OF  ECONOMICS 

each  tenant  was  not  a  compact  area,  but  was  composed  of  strips 
scattered  in  the  three  great  fields  into  which  the  arable  land  was 
divided  for  purposes  of  crop  rotation. 

Some  handicraftsmen  were  also  found  upon  the  estate,  but  they  do  not 
occupy  an  important  place  in  the  economy  of  the  village.  For  the  most  part, 
they  were  probably  slaves  or  household  servants.  Slaves  in  England  con- 
stituted at  the  time  of  the  Conquest  about  nine  per  cent  of  the  population, 
but  "in  some  of  the  eastern  and  midland  shires  do  not  appear  at  all,  or  fall 
to  a  percentage  of  four  or  five,"  while  they  rise  to  as  much  as  twenty-four 
per  cent  in  other  parts  of  the  country.  "We  cannot  but  explain  this  by  the 
supposition  that  in  the  later  stages  of  the  English  conquest  a  greater  number 
of  the  British  cultivators  were  spared,  so  that  in  these  districts  slaves  came  to 
form  a  considerable  part  of  the  rural  population.  Absolute  slavery,  how- 
ever, disappeared  in  less  than  a  century  after  the  Conquest,  and  the  servi 
became  customary  holders  of  small  plots,  like  the  cotters  elsewhere,  but  on 
more  onerous  conditions."  1 

These  manors  were  largely  self-sufficient  in  their  economic  life. 
There  was,  to  be  sure,  some  trade.  England  exported  raw 
products  to  the  continent  and  received  back  some  of  the  finer 
forms  of  manufacture.  But  the  ordinary  needs  of  the  very 
frugal  life  which  the  tenants  had  to  live  were  supplied  by  prod- 
ucts of  the  manor  itself.  During  the  centuries  following  the 
Norman  Conquest  important  changes  took  place  in  the  manorial 
system :  (i)  a  rapid  growth  in  the  number  of  free  tenants ; 
(2)  the  commutation  of  customary  services  into  fixed  payments 
in  money  or  kind;  and  (3)  the  appearance  of  a  class  of  agri- 
cultural laborers  dependent  on  the  wages  which  they  received. 

In  contrasting  the  manorial  economy  with  the  village  of  the 
present  day,  Professor  W.  J.  Ashley  has  pointed  out  the  follow- 
ing differences :  (1)  Now  English  farmers  generally  live  in 
separate  homesteads  among  the  fields  they  rent,  but  then  all  the 
cultivators  lived  side  by  side  in  the  village  street.  (2)  Now 
each  farmer  follows  his  own  judgment  as  to  his  agricultural 
operations,  but  in  this  early  period  he  took  his  share  in  the 
common  method  of  cultivation,  which  was  regulated  by  custom, 
enforced  by  the  manor  courts.  (3)  Today,  if  the  landlord 
himself  engages  in  farming,  his  management  is  independent 

1  Sec  Ashley,  English  Economic  History,  vol.  i,  pp.  17-18. 


THE   EVOLUTION  OF   ECONOMIC   SOCIETY  39 

of  that  of  his  tenants,  but  under  the  manorial  system  he  de- 
pended almost  exclusively  upon  the  labor  of  his  tenants,  who 
contributed  plows,  oxen,  and  men.  (4)  Aside  from  the  great 
gulf  between  lord  and  tenants,  there  was  then  no  such  social 
separation  between  the  cultivators  as  there  is  today  between 
large  and  small  farmers.  The  manorial  economy  of  England 
was  a  type,  though  somewhat  more  systematically  developed, 
of  conditions  on  the  continent  of  Europe. 

IV.  The  Handicraft  Stage 

This  stage  begins  with  the  development  of  towns  as  centers 
of  trade  and  handicraft  in  the  latter  part  of  the  Middle  Ages 
and  extends  to  the  introduction  of  power  manufacture  in  the 
latter  part  of  the  eighteenth  century.  During  such  a  long 
period  many  changes  took  place  in  the  economic  life  of  the 
people  of  Europe,  but  so  far  as  the  growth  of  man's  power  over 
nature  is  concerned  the  whole  period  is  in  marked  contrast  with 
the  modern  era  of  machine  production. 

The  Gild  System.  —  The  growth  of  trade  brought  with  it  the 
merchant  gild,  the  purpose  of  which  was  to  regulate  the  conduct 
of  trade  and  to  keep  a  monopoly  of  it  for  the  merchants  of  the 
town.  Merchant  gilds  appeared  in  all  the  larger  towns  of  Eng- 
land in  the  twelfth  century.  But  a  new  class  was  developing  in 
the  towns,  —  the  craftsmen  who  were  engaged  in  the  making  of 
things  for  sale.  As  this  handicraft  grew  in  importance,  the 
merchant  gild  was  superseded  by  the  craft  gild,  which  in  England 
attained  its  fullest  development  in  the  first  half  of  the  fourteenth 
century.  Each  craft  had  its  gild,  which  specified  in  detail  how 
the  business  should  be  carried  on,  how  many  should  be  admitted 
to  it,  and  how  the  trade  should  be  learned.  This  growth  in  spe- 
cialization meant  also  a  growth  in  trade,  but  in  this  early  part  of 
the  handicraft  period,  commerce  was  much  restricted  as  com- 
pared with  that  of  the  present  day.  The  towns  made  exchanges 
mostly  with  the  country  surrounding  them,  there  being  as 
yet  no  national  or  world  market  of  any  importance.  Plainly 
such  a  general  system  of  exchange  could  not  be  carried  on  by 
barter,  and  in  this  period  money  became  increasingly  important. 


40  OUTLINES  OF  ECONOMICS 

The  agricultural  stage  had  in  the  greater  part  of  Europe  cul- 
minated in  the  feudal  system.  The  nobility  maintained  order 
and  attended  to  the  fighting  while  the  serfs  tilled  the  soil.  The 
manufacturing  cities  became  the  rivals  of  the  feudal  lords,  who 
felt  their  power  threatened,  and  hence  they  bitterly  opposed 
the  cities.  The  cities  were  free,  and  the  serfs  who  fled  to  them 
were  accepted  and  made  freemen. 

The  Domestic  System.  —  With  the  beginning  of  the  modern 
period  the  town  system  gave  way  to  a  larger  economy.  The 
towns  lost  the  control  of  trade.  The  gild  system  was  gradually 
succeeded  by  the  domestic  system,  which  developed  in  the 
sixteenth  and  seventeenth  centuries  and  was  a  characteristic 
feature  of  English  industry  until  the  middle  of  the  eighteenth 
century.  As  in  the  gild  system,  industry  was  carried  on  by 
hand  in  a  small  way,  but  the  functions  of  merchant  and  workman 
were  now  separated.  The  gild  master  sold  the  goods  which  he 
produced  in  his  shop  directly  to  the  customers  who  were  to  use 
the  goods,  but  under  the  domestic  system  the  workman  came 
to  be  less  independent.  He  received  the  raw  material  from  a 
middleman,  to  whom  he  also  delivered  the  finished  product. 
Much  of  this  work  was  done  outside  of  the  towns,  the  artisans 
thus  being  enabled  to  devote  part  of  their  time  to  agriculture. 
Defoe,  in  his  tour  through  Great  Britain  (i 724-1 726),  describes 
the  methods  employed  as  follows : 

The  land  "  was  divided  into  small  inclosures  from  two  acres  to  six  or  seven 
each,  seldom  more ;  every  three  or  four  pieces  of  land  had  an  house  belonging 
to  them,  .  .  .  hardly  an  house  standing  out  of  a  speaking  distance  from 
another.  .  .  .  We  could  see  at  every  house  a  tenter,  and  on  almost  every 
tenter  a  piece  of  cloth  or  kersie  or  shaloon.  ...  At  every  considerable 
house  was  a  manufactury.  .  .  .  Every  clothier  keeps  one  horse,  at  least, 
to  carry  his  manufactures  to  the  market,  and  every  one  generally  keeps  a 
cow  or  two  or  more  for  his  family.  By  this  means  the  small  pieces  of  in- 
closed land  about  each  house  are  occupied,  for  they  scarce  sow  corn  enough 
to  feed  their  poultry.  .  .  .  The  houses  are  full  of  lusty  fellows,  some  at  the 
dye-vat,  some  at  the  looms,  others  dressing  the  cloths ;  the  women  or  chil- 
dren carding  or  spinning,  being  all  employed,  from  the  youngest  to  the  oldest." 

Agricultural  Changes.  —  Many  important  changes  in  the 
agriculture  of  England  took  place  during  the  handicraft  stage. 


THE  EVOLUTION  OF  ECONOMIC  SOCIETY  41 

The  most  prominent  of  these  is  the  process  called  inclosure. 
Under  the  manorial  system  the  lands  in  the  common  fields  were 
the  property  of  a  landlord,  but  his  rights  were  not  exclusive 
and  were  qualified  by  rights  of  the  tenants.  There  existed  a 
certain  kind  of  partnership  of  landlord  and  tenant  in  the  culti- 
vation of  the  land.  Inclosure  is  the  term  used  to  designate 
the  dissolution  of  the  partnership,  or  the  separation  of  rights. 
After  inclosure  the  tenant  had  generally  a  farm  which  was  in 
one  piece  of  land,  instead  of  being  in  scattered  strips  in  different 
fields,  and  for  this  he  paid  usually  a  definite  money  rent.  The 
farmer  could  make  improvements  on  his  own  account,  which 
was  impossible  when  he  held  scattered  strips  in  great  fields. 
Inclosures  were  made  during  this  whole  period  and  especially 
during  the  Tudor  period.  Farms  became  larger  and  when 
labor  was  scarce  and  wages  high,  sheep  farming,  requiring  few 
laborers,  was  rapidly  extended.  Inclosures  resulted  in  great 
agricultural  improvement,  but  at  the  same  time  they  were 
frequently  attended  with  hardship  for  the  poorer  people.  Some- 
times the  common  rights,  especially  those  of  common  pasturage, 
were  not  fully  paid  for,  although  the  rule  was  that  of  compensa- 
tion. But  the  result  was  to  separate  many  people  from  the 
land ;  frequently  the  payment  received  by  the  poorer  people 
was  wasted.  The  right  to  pasture  a  cow  meant  a  definite  con- 
nection with  the  soil ;  the  money  received  in  payment  for  this 
right  might  quickly  disappear.  Even  now  in  English  villages 
it  is  possible  to  find  those  who  receive  small  sums  for  ancient 
rights,  and  these  are  too  often  used  in  dissipation.  In  Epworth, 
England,  the  villagers  formerly  had  a  right  to  cut  turf  in  a  field 
which  is  now  let  for  a  money  rent,  and  this  is  used  to  buy  coal 
which  is  distributed  among  the  people  in  payment  of  their  an- 
cient rights. 

Convertible  husbandry,  rotation  of  crops,  the  cultivation  of 
root  crops,  improved  breeds  of  animals  and  other  forms  of 
agricultural  progress  accompanied  inclosure,  which  is  still 
going  forward,  although  the  process  is  nearly  completed  so  far 
as  the  arable  land  is  concerned.  A  halt  has  now  been  called  to 
the  inclosure  of  forests  and  common  fields,  especially  when  used 


42  OUTLINES  OF  ECONOMICS 

for  pasturage,  and  these  are  now  found  scattered  over  England 
and  used  as  public  parks  and  playgrounds;  but  often  with 
certain  private  rights  of  pasturage  which  have  descended  to 
their  owners  by  inheritance  or  which  have  been  acquired  other- 
wise, as  by  the  purchase  of  a  cottage  to  which  the  rights  are 
attached.  An  illustration  of  a  village  with  extensive  common 
fields  is  afforded  today  by  Stelling  Minnis,  near  Canterbury, 
England. 

The  Mercantile  System.  —  The  decay  of  town  authority  did 
not  mean  that  industry  and  commerce  were  left  to  the  free  play 
of  competition.  The  supervision  of  the  central  government 
took  the  place  of  that  of  the  towns.  The  national  system  of 
regulation  has  been  called  the  Mercantile  System,  which  pre- 
vailed in  England  (and  in  other  countries)  from  the  sixteenth 
century  to  the  nineteenth.  Its  essential  idea  is  the  guidance  of 
economic  affairs  in  such  a  way  as  to  increase  the  commercial 
and  military  power  of  the  nation  as  a  whole.  The  navigation 
laws  which  the  student  has  met  with  in  his  study  of  American 
history  were  a  part  of  this  system.  An  attempt  was  made  to 
create  a  "  favorable  "  balance  of  trade  and  to  maintain  a  good 
supply  of  the  precious  metals.  Agriculture  was  fostered  with 
the  aim  of  promoting  the  growth  of  population.  The  mercantile 
system  has  often  been  described  as  consisting  chiefly  of  trade 
restrictions,  but  it  is  the  contention  of  Professor  Schmoller 
that  in  its  essence  the  system  meant  "  the  replacing  of  a  local 
and  territorial  economic  policy  by  that  of  the  national  state." 

It  was  characteristic  of  the  mercantile  system,  too,  to  interfere 
in  the  conduct  of  internal  trade.  Prices,  wages,  and  the  rules 
of  apprenticeship  were  fixed  by  public  authority.  The  quality 
of  goods  was  inspected  by  public  officials.  Patents  of  monopoly 
on  the  sale  of  certain  commodities,  such  as  gunpowder,  matches, 
and  playing  cards,  were  extensively  granted  by  royal  authority 
to  favored  individuals  or  companies,  ostensibly  to  foster  new 
industries. 

"At  the  Council  of  York,  Charles  was  obliged  to  declare  many  of  the 
industrial  patents  void;  but  enough  remained  to  call  forth  an  indignant 
declamation  from  Sir.  J.  Colepepper  in  the  Long  Parliament :   'I  ha    *.  but 


THE  EVOLUTION  OF   ECONOMIC   SOCIETY 


43 


one  Grievance  more  to  offer  unto  you ;  but  this  one  compriseth  many ;  it 
is  a  nest  of  wasps,  or  swarm  of  vermin,  which  have  overcrept  the  land, 
I  mean  the  monopoler  and  polers  of  the  people.  These  like  the  frogs  of 
Egypt,  have  got  possession  of  our  dwellings,  and  we  have  scarce  a  room  free 
from  them ;  they  sip  in  our  cup,  they  dip  in  our  dish,  they  sit  by  our  fire ; 
we  find  them  in  the  dye- vat,  wash-bowl,  and  powdery  tub ;  they  share  with 
the  butler  in  his  box,  they  have  marked  us  and  sealed  us  from  head  to  foot. 
Mr.  Speaker,  they  will  not  bate  us  a  pin ;  we  may  not  buy  our  own  cloaths 
without  their  brokage.  These  are  the  leeches  that  have  sucked  the  com- 
monwealth so  hard  that  it  is  almost  become  hectical.  And  some  of  these 
are  ashamed  of  their  right  names ;  they  have  a  vizard  to  hide  the  brand 
made  by  that  good  law  in  the  last  Parliament  of  King  James ;  they  shelter 
themselves  under  the  name  of  a  corporation;  they  make  bye-laws  which 
serve  their  turns  to  squeeze  us  and  to  fill  their  purses ;  unface  these  and  they 
will  prove  as  bad  curs  as  any  in  the  pack.  These  are  not  petty  chapmen,  but 
wholesale  men.'"  x 

A  full  account  of  this  stage  in  English  history  would  deal  with 
(i)  the  regulation  of  labor,  including  the  Statute  of  Artificers 
passed  in  the  reign  of  Elizabeth,  which  provided  that  all  able- 
bodied  men  might  be  compelled  to  serve  as  agricultural  laborers, 
and  that  all  artificers,  rural  or  urban,  should  undergo  an  appren- 
ticeship of  at  least  seven  years.  In  this  same  reign  provision  was 
made  for  the  assessment  of  wages  by  the  Justices  of  the  Peace. 
Every  year  in  each  locality  the  justices  were  to  assemble,  and, 
"  calling  to  them  such  discreet  and  grave  persons  ...  as  they 
shall  think  meet,  and  conferring  together  respecting  the  plenty 
or  scarcity  of  the  time,"  they  were  to  fix  the  wages  for  every 
kind  of  manual  labor,  skilled  or  unskilled,  by  the  year,  week,  or 
day,  and  with  or  without  allowance  of  food.  A  full  account 
would  deal  also  with:  (2)  the  development  of  systematic  poor 
relief  by  civil  authority ;  (3)  the  encouragement  of  shipping  and 
of  (4)  the  immigration  of  foreign  artisans  to  introduce  new  in- 
dustries ;  (5)  the  regulation  of  the  corn  trade ;  (6)  the  establish- 
ing of  plantations  in  the  colonies  ;  (7)  the  regulation  of  the  coin- 
age; (8)  the  development  of  banking,  insurance,  and  foreign 
commerce,  and  the  decay  of  the  old  notions  regarding  the  sinful- 
ness of  interest  taking. 

1  Cunningham,  English  Commerce  and  Industry,  Modern  Times,  Part  i,  pp 
307-308. 


44  OUTLINES  OF  ECONOMICS 

V.  The  Industrial  Stage 

In  the  latter  part  of  the  eighteenth  century,  the  slow-going 
methods  of  the  handicraft  stage  were  radically  changed  by  the 
Industrial  Revolution.  The  fundamental  feature  of  this  change 
is  the  introduction  of  power  manufacture.  The  industrial  revo- 
lution and  the  chief  features  of  the  industrial  stage  will  be  dis- 
cussed in  the  following  chapter. 

Before  proceeding  to  the  consideration  of  the  last  stage,  it 
will  be  well  to  notice  some  of  the  other  views  which  have  been 
expressed  concerning  the  periods  of  economic  development.  The 
German  economist,  Hildebrand,  has  taken  as  his  principle  of 
classification  the  method  of  exchanging  goods,  and  from  this 
standpoint  he  gets  the  following  three  stages :  (i)  barter,  (2) 
money,  and  (3)  credit.  All  three  methods  of  exchanging,  to  be 
sure,  are  in  use  at  the  present  time,  but  the  extensive  use  of 
credit  is  the  new  and  characteristic  thing  about  present-day 
exchange.  It  has  been  objected  that  the  period  before  the  use 
of  money  became  prominent  is  characterized  not  so  much  by 
the  barter  of  goods  as  by  the  fact  that  exchange  itself  is  unim- 
portant. 

Another  writer  (Biicher)  has  divided  economic  history  accord- 
ing to  the  nature  and  size  of  the  normal  self-sufficing  economic 
unit,  as  follows :  (1)  the  independent  domestic  economy,  (2)  the 
town  economy,  (3)  the  national  economy. 

In  the  first  stage  the  interval  between  production  and 
consumption  is  small.  Things  are  produced  where  they  are 
consumed,  ■  3  in  the  village  communities  of  the  early  middle 
ages.  In  the  town  economy  the  interval  is  somewhat  greater. 
The  artisans  in  the  town  produce  for  the  consumption  of  other 
persons,  for  the  most  part  in  the  immediate  neighborhood,  so 
that  the  producer  meets  the  consumer  without  intermediaries. 
In  the  third  stage,  production  is  for  a  national  market,  so  that 
goods  may  pass  through  many  hands  before  reaching  the 
consumer,  and  the  system  of  cooperative  division  of  labor 
embraces  the  whole  nation.  Possibly,  according  to  this  view,  a 
fourth  stage  might  be  added,  —  that  of  a  nascent  world  economy. 


THE   EVOLUTION  OF   ECONOMIC   SOCIETY 


45 


Again,  we  might  pay  attention  chiefly  to  the  condition  of 
labor.  Beginning  with  a  condition  where  there  is  no  distinct 
laboring  class,  we  pass  through  slavery  and  serfdom  to  free 
labor,  regulated  at  first  by  law  and  custom,  then  by  individual 
contract,  and  finally  in  large  measure  by  group  contract  or  col- 
lective bargaining  supplemented  to  an  increasing  extent  by 
legal  regulations  of  a  new  kind. 


THE   ECONOMIC   STAGES 


From  the 
Standpoint 
of  Produc- 
tion 

From 
Bucher's 
Standpoint 

From 
Hildebrand's 
Standpoint 

From 
the  Labor 
Standpoint 

Illustrations 
from  English 
History 

I. 

Direct  Ap- 
propriation 

Independent 
Domestic 
Economy 

Barter 
Economy 

Laboring 
class  not  dif- 
ferentiated 

Prehistoric 

2. 

Pastoral 

Before  Christ 

3- 

Agricultural 

Slavery  and 
Serfdom 

nth- 1 4th 
Centuries 

4- 

Handicraft 

Town 
Economy 

Money 
Economy 

Free  Labor 
governed 
by  Custom 

I3th-i8th 

Centuries 

5- 

Industrial 

National 
Economy 

Credit 

Economy 

Individual 
Contract 

Group 
Contract 

i8th  Century 
to  the  Pres- 
ent Time 

These  various  classifications  are  not  contradictory;  on  the 
contrary,  they  supplement  each  other.  Still  other  divisions 
are  possible.  In  the  preceding  table  these  various  points  of 
view  are  roughly  correlated  and  applied  to  the  history  of 
England.  These  divisions  of  time  are  in  no  sense  accurate,  and 
are  intended  merely  to  be  suggestive. 


46  OUTLINES  OF  ECONOMICS 

QUESTIONS  AND  EXERCISES 

i.   Write  a  description  of  the  economic  life  of  a  tribe  in  one  of  the  first  two 
stages. 

2.  What  is  the  difference  between  slavery  and  serfdom? 

3.  Give  an  account  of  the  East  India  Company. 

4.  Sketch  the  development  of  the  woolen  industry  in  England  to  1760. 

5.  Give  an  account  of  the  origin  of  the  Bank  of  England. 

6.  Summarize  the  history  of  poor  relief  in  England. 

7.  It  has  been  held  that  because  economic  progress  has  been  continuous, 
it  is  incorrect  to  divide  it  into  "  stages. "     Discuss  this  view. 

REFERENCES 

Ashley,  W.  J.  English  Economic  History,  Vol.  i ;  and  The  Economic  Or- 
ganization of  England,  Chaps,  i-v. 

Buchee,  Karl.    Industrial  Evolution  (trans,  by  S.  M.  Wickett). 

Cheyney,  E.  P.     Industrial  a)td  Social  History  of  England,  Chaps,  i  to  vii. 

Cunningham,  William.  Growth  of  English  Industry  and  Commerce,  Vol.  i. 
(Middle  Ages)  and  Vol.  ii  (Mercantile  System). 

Ely,  R.  T.     Evolution  of  Industrial  Society,  Part  i,  Chap.  iii. 

Gonner,  E.  C.  K.     Common  La>id  and  Inclosure. 

Hone,  N.  J.     The  Manor  and  Manorial  Records. 

Lipson,  Ephraim.  An  Introduction  to  the  Economic  History  of  England, 
Vol.  i. 

Meredith,  H.  O.     Outlines  of  the  Economic  History  of  England. 

Morgan,  L.  H.    Ancient  Society,  Chap.  i. 

Prothero,  R.  E.     English  Farming,  Past  and  Present,  Chaps,  iii,  iv,  vii,  xi. 

Ratzel,  Friedrich.     History  of  Mankind  (trans,  by  A.  J.  Butler),  3  vols. 

Salzmann,  L.  F.     English  Industries  of  the  Middle  Ages. 

Schmoller,  Gustav.  Tlie  Mercantile  System  (Economic  Classics,  edited  by 
W.  J.  Ashley). 

Seebohm,  Frederic.     The  English  Village  Community. 

Stanley,  H.  M.     In  Darkest  Africa,  Vol.  i,  Chap,  xxiii. 

Unutn,  George.     The  Guilds  and  Companies  of  London. 

ViNOGRADOFF,  Paul.     The  Growth  of  the  Manor. 

Wallace,  A.  R.    Russia  (edition  of  1905),  Chap.  viii. 


CHAPTER  IV 
THE  EVOLUTION  OF  ECONOMIC   SOCIETY  {Continued) 

The  Industrial  Revolution.  —  The  passage  from  the  handi- 
craft to  the  industrial  stage  in  England  is  generally  known  as 
the  Industrial  Revolution.  It  has  been  objected  that  this 
term  is  misleading  because  the  introduction  of  the  modern  fac- 
tory system  required  many  years  and  was  but  the  working  out 
of  conditions  that  had  been  long  maturing.  It  is  true  that  the 
growth  in  the  division  of  labor,  the  expansion  of  commerce,  and 
the  technical  progress  of  former  ages  were  necessary  preliminaries 
to  the  industrial  revolution,  but  there  is  little  danger  of  over- 
emphasizing the  importance  or  the  rapidity  of  the  change. 
The  period  from  1770  to  1840,  the  span  of  a  single  life,  is,  after 
all,  a  short  period  from  the  standpoint  of  the  historian.  Yet 
the  changes  of  this  period  swept  away  the  inefficient  methods 
that  had  been  used  for  centuries,  and  caused  profound  modifi- 
cations in  social  structure.  To  understand  the  nature  of  this 
movement,  we  must  review  the  condition  of  things  before  it 
began. 

England  in  1760.  —  England  was  at  this  time  largely  self- 
sufficing  in  its  economic  life,  producing  for  itself  its  food  and  other 
articles  of  ordinary  consumption,  although  compared  with  medi- 
eval days  there  had  been  a  marked  expansion  of  international 
and  colonial  trade.  Woolen  goods  were  the  most  important  ex- 
port. The  imports  consisted  largely  of  wines,  spirits,  rice, 
sugar,  coffee,  oil,  and  furs,  and  some  wool,  hemp,  silk,  and  linen 
yarn.  Within  the  nation,  too,  there  was  not  such  a  degree  of 
specialization  of  industry  in  particular  localities  as  is  found  at 
the  present  day,  although  the  beginning  of  such  localization  had 
clearly  been  made  in  the  textile  and  iron  industries.  On  the 
whole,  however,  the  commerce  between  the  different  sections 

47 


48  OUTLINES  OF  ECONOMICS 

of  the  country  was  slight.  The  means  of  transportation  were 
exceedingly  poor,  notwithstanding  the  growth  of  turnpike  roads. 
The  roads  were  described  by  a  traveler  as  "  most  execrably 
vile."  Such  was  their  condition  that  pack  horses  were  still  a 
common  means  of  getting  goods  to  market.  Rivers  were  im- 
portant highways,  canal  building  having  barely  begun. 

The  system  of  hand  manufacture  was  still  in  general  opera- 
tion. Although  the  workmen  under  the  domestic  system  were 
no  longer  owners  of  the  material  upon  which  they  worked,  yet 
the  tools  they  used  were  their  property.  The  beginnings  of 
certain  features  of  the  factory  system,  however,  are  to  be  seen 
long  before  the  use  of  power  machinery,  for  in  some  cases  work- 
men were  employed  in  large  numbers  in  buildings  owned  by 
the  employer,  who  also  furnished  the  mechanical  equipment. 
But  to  a  large  extent  manufacturing  was  combined  with  agri- 
culture, not  only  in  the  textile  trades,  but  in  other  branches 
also.  "  At  West  Bromwich,  a  chief  center  of  the  metal  trade, 
agriculture  was  still  carried  on  as  a  subsidiary  pursuit  by  the 
metal  workers." 

The  medieval  system  of  common  field  tillage  was  extensively 
used,  a  large  part  of  the  land  being  still  uninclosed.  The  culti- 
vation was  exceedingly  poor,  but  important  experiments  tend- 
ing toward  a  "  new  agriculture  "  were  being  made  in  the  second 
quarter  of  the  eighteenth  century  by  Jethro  Tull  and  "  Turnip  " 
Townshend.  Of  the  whole  number  of  farms,  approximately 
one  half  "  were  owned  and  occupied  by  the  various  classes  of 
freeholders  and  copyholders ;  that  is,  by  land-owning  farmers." 

The  medieval  notion  of  the  relation  of  government  to  in- 
dustry was  still  nominally  in  force.  Detailed  and  special 
legislation  was  supposed  to  be  the  means  of  securing  a  well- 
ordered  trade,  as  explained  in  the  preceding  chapter.  But  a 
tremendous  revolt  had  begun  against  this  whole  system.  This 
revolt  had  its  religious  and  political  as  well  as  its  economic- 
aspect.  The  same  year  that  Thomas  Jefferson  wrote  the  Dec- 
laration of  Independence,  asserting  that  all  men  are  by  nature 
equal,  Adam  Smith  published  the  Wealth  of  Nations,  the  most 
influential  book  ever  written  on  economics. 


THE  EVOLUTION  OF   ECONOMIC   SOCIETY  49 

"Every  individual,"  said  Smith,  "is  continually  exerting  himself  to  find 
out  the  most  advantageous  employment  for  whatever  capital  he  can  com- 
mand. It  is  his  own  advantage,  indeed,  and  not  that  of  the  society,  which 
he  has  in  view.  But  the  study  of  his  own  advantage,  naturally,  or  rather 
necessarily,  leads  him  to  prefer  that  employment  which  is  most  advantageous 
to  society.  .  .  .  What  ;s  the  species  of  domestic  industry  which  his  capital 
can  employ,  and  of  which  the  produce  is  likely  to  be  of  the  greatest  value, 
every  individual,  it  is  evident,  can,  in  his  local  situation,  judge  much  better 
than  any  statesman  or  lawgiver  can  for  him."  1 

The  Mechanical  Inventions.  —  During  the  last  half  of  the 
eighteenth  century  the  progress  of  invention  was  exceptionally 
rapid.  Kay's  flying  shuttle  (1738)  had  facilitated  the  weaving 
process  to  such  an  extent  that  it  became  difficult  to  secure 
enough  yarn  from  the  spinners.  Hand  spinning  was  improved 
by  Hargreave's  "jenny"  about  1767;  Arkwright,  in  1771, 
made  a  practical  success  of  roller  spinning  (a  method  patented 
long  before) ,  using  horse  power,  and  later,  water  power.  Cromp- 
ton  combined  these  two  processes  in  1779.  After  1785  steam 
power  was  applied  to  cotton  spinning,  and  then  it  was  the  weav- 
ing process  that  was  felt  to  be  too  slow.  Cartwright  began  his 
experiments  in  1784,  but  the  power  loom  did  not  come  into 
general  use  until  early  in  the  nineteenth  century. 

The  improvement  in  the  steam  engine  also  made  possible 
great  advances  in  the  iron  industry,  of  fundamental  importance 
in  an  age  of  machinery.  The  production  of  English  iron  was 
over  seventy-five  times  as  great  in  1 840  as  it  had  been  in  1 740. 

The  need  for  better  transportation  was  met  by  improved 
roads,  by  the  building  of  canals  (especially  1790  to  1805),  and 
by  the  development  of  steam  locomotion.  The  germ  of  the 
modern  railway  is  seen  in  the  tramways  used  in  the  coal  mines. 
Cast  iron  rails  were  used  as  early  as  1738.  The  first  tramway 
to  be  used  for  public  purposes  was  chartered  in  1801,  the  cars 
to  be  drawn  by  horse  power.  Trevithick  made  a  locomotive 
in  1803  that  was  of  practical  use.  In  1814  Stephenson  con- 
structed a  locomotive  that  could  draw  a  load  of  thirty  tons  at 
the  rate  of  three  miles  an  hour.  The  Stockton  and  Darlington 
road  was  opened  in  1825  with  a  Stephenson  locomotive  that 

1  A.  Smith,  Wealth  of  Nations,  Book  iv,  Chap.  ii. 
v. 


50  OUTLINES   OF  ECONOMICS 

made  fifteen  miles  an  hour,  but  two  years  later  the  directors  of 
the  road  considered  the  advisability  of  abandoning  the  use  of 
locomotives.  In  1829  the  directors  of  the  Liverpool  and  Man- 
chester Railroad  arranged  a  prize  contest  to  determine  the 
practicability  of  steam  locomotion.  The  success  of  Stephenson's 
"  Rocket  "  in  meeting  the  requirements  of  the  contest  demon- 
strated that  the  new  method  of  locomotion  had  come  to  stay. 

"A  general  survey  of  the  growth  of  new  industrial  methods  in  the  textile 
and  iron  industries  marks  out  three  periods  of  abnormal  activity  in  the  evolu- 
tion of  modern  industry.  The  first  is  1780-1795,  when  the  fruits  of  early 
inventions  were  ripened  by  the  effective  application  of  steam  to  the  machine 
industries.  The  second  is  1830  to  1845,  when  industry,  reviving  after  the 
European  strife,  utilized  more  widely  the  new  inventions,  and  expanded 
under  the  stimulus  of  steam  locomotion.  The  third  is  1856-1866  (circa), 
when  the  construction  of  machinery  by  machinery  became  the  settled  rule 
of  industry."  * 

Agricultural  Changes.  —  During  the  Industrial  Revolution 
there  were  also  important  changes  in  agriculture.  Bakewel!, 
in  the  second  half  of  the  eighteenth  century,  improved  the  breeds 
of  sheep  and  cattle.  The  inclosing  of  the  common  fields  pro- 
ceeded with  great  rapidity,  not,  as  in  the  sixteenth  century,  for 
the  purpose  of  sheep  raising,  but  to  permit  of  more  efficient 
tillage  of  the  soil.  Between  1760  and  1850  over  seven  million 
acres  were  inclosed  in  England.  The  small  land-owning  farmer 
was  crowded  out,  partly  because  more  investment  per  acre  was 
needed  with  the  new  agriculture,  partly  because  "  gentlemen 
farmers  "  (men  who  had  made  money  in  other  pursuits  and  took 
up  agriculture  because  it  was  fashionable)  bought  them  out, 
and  because  the  price  of  land  was  greatly  increased  by  the  desire 
of  wealthy  men  to  build  up  family  estates.  Today  practically 
all  English  farmers  are  tenants.  The  small  farmer,  who  under 
the  domestic  system  was  also  frequently  a  handicraftsman,  was 
thus  crushed  between  the  new  agriculture  and  the  new  industry. 

"Hitherto  the  rude  implements  required  for  the  cultivation  of  the  soil, 
or  the  household  utensils  needed  for  the  comfort  of  daily  life,  had  been  made 
at  home.     The  farmer,  his  sons,  and  his  servants  in  the  long  winter  evenings 

1  Hobson,  Evolution  of  Modern  Capitalism,  edition  of  1907,  p.  89. 


THE   EVOLUTION   OF  ECONOMIC   SOCIETY  51 

carved  the  wooden  spoons,  the  platters,  and  the  beechen  bowls,  plaited  wicker 
baskets,  fitted  handles  to  the  tools,  cut  willow  teeth  for  rakes  and  harrows 
and  hardened  them  in  the  fire,  fashioned  ox  yokes  and  forks,  twisted  willows 
into  the  traces  of  other  harness  gear.  Traveling  carpenters  visited  farm- 
houses at  rare  intervals  to  perform  those  parts  of  work  which  needed  their 
professional  skill.  The  women  plaited  the  straw  for  the  neck  collars,  stitched 
and  stuffed  sheepskin  bags  for  the  cart  saddle,  wove  the  straw  and  hempen 
stirrups  and  halters,  peeled  the  rushes  for  and  made  the  candles.  The 
spinning  wheel,  the  distaff,  and  the  needle  were  never  idle ;  coarse  hand-made 
cloth  and  linen  supplied  all  wants ;  every  farmhouse  had  its  brass  brewery 
kettle.  ...  All  the  domestic  industries  by  which  cultivators  of  the  soil 
increased  their  incomes,  or  escaped  the  necessity  of  selling  their  produce, 
were  now  supplanted  by  manufactures."  1 

Effects  of  the  Industrial  Revolution.  —  As  has  already  been 
indicated,  the  Industrial  Revolution  introduces  one  of  the  great 
stages  in  the  development  of  man's  power  over  nature.  But 
along  with  the  new  opportunities  came  also  new  dangers  and 
perplexing  problems. 

1.  The  Factory  System.  —  The  use  of  expensive  machinery 
and  steam  power  made  it  impossible  for  men  to  carry  on  their 
work  in  their  own  homes.  The  factory  supplanted  the  home  as 
the  typical  center  of  production.  Instead  of  working  by  them- 
selves or  with  a  few  assistants,  men  now  to  a  much  greater 
extent  than  before  had  to  congregate  in  cities,  and  submit  to  a 
new  discipline  in  large  groups  organized  for  purposes  of  pro- 
duction. This  brought  with  it  a  new  division  of  society  into 
classes.  The  machine  and  the  workshop,  as  well  as  the  raw 
material  and  the  product,  are  at  no  stage  in  the  productive 
process  owned  by  the  men  who  do  the  manual  work.  The 
masses  become  wage  earners.  Now,  in  some  industries  not  one 
in  a  hundred  can  by  exceptional  ability  become  an  independent 
employer,  and  the  workman  knows  that  he  is  a  workman  for 
life.  So  we  have  now  two  industrial  classes,  laborers  and 
capitalists,  with  a  great  gulf  between  them  which  comparatively 
few  men  can  cross,  and  with  interests  which  often  seem  irrec- 
oncilable.     What  the  ultimate   effects  of  the  new  system  of 

1  Prothero,  quoted  by  Cunningham,  Growth  of  English  Industry  and  Commerce 
Modern  Times,  Part  ii.  n.  722. 


52  OUTLINES  OF  ECONOMICS 

production  will  be  cannot  be  stated,  but  it  has  been  suggested 
that  these  changes  in  external  relations  are  affecting  also  men's 
habits  of  thought.  Can  we  expect  the  institution  of  private 
property  to  seem  as  natural  and  sacred  to  those  who  have 
nothing  to  do  with  the  buying  and  selling  of  products  as  to  those 
who  engage  much  in  pecuniary  transactions?  It  has  been 
suggested  that  the  feeling  that  we  have  a  right  to  the  product 
of  our  own  labor  is  merely  a  survival  of  the  era  of  small-scale 
hand  manufacture. 

2.  The  Expansion  of  Markets  and  Industrial  Specialization.  — 
Along  with  the  new  methods  of  production  there  has  been  a 
change  from  restricted  local  markets  to  national  and  even  world 
markets.  Improved  methods  of  transportation  make  it  possible 
for  different  branches  of  production  to  be  localized  in  regions 
where  there  are  special  facilities  for  raw  material  or  power.  This 
implies  greater  economic  interdependence  and  greater  liability 
to  trade  fluctuations  and  disturbances.  One  great  advantage 
of  the  old  slow-going  system  of  manufacture  and  trade  was  its 
regularity.  As  the  area  of  the  market  increases,  manufacturers 
find  it  more  difficult  to  decide  what  and  how  much  to  produce. 
Trade  fluctuations  have  increased  in  severity  with  the  growth 
of  large-scale  production.  This  is  due  not  merely  to  the  chang- 
ing and  enlarging  demand  which  cannot  be  calculated,  but  also 
to  the  fact  that  manufacture  itself  is  constantly  being  disturbed 
by  improvements  which  cannot  be  foreseen.  It  is  possible 
that  a  still  larger  scale  of  manufacture  hereafter  will  bring  steadi- 
ness in  industry,  but  whatever  the  cause  of  these  fluctuations, 
the  effect  upon  the  wage  earner  is  demoralizing.  If  he  were 
wise  enough  to  save  his  earnings  during  good  times,  and  so  have 
something  for  hard  times,  he  would  not  suffer  so  much.  But 
very  few  people  who  live  in  abundance  can  do  this ;  how  much 
less  those  whose  condition  even  in  good  times  is  one  of  meager 
comfort ! 

Evils  of  the  Transitional  Period.  —  The  condition  of  the 
English  working  classes  in  the  latter  part  of  the  eighteenth  and 
early  nineteenth  centuries  was  undoubtedly  worse  than  in  any 
other  period  in  the  history  of  the  country.     It  is  difficult  to 


THE    EVOLUTION   OF   ECONOMIC   SOCIETY 


53 


say  to  what  extent  this  was  due  to  the  introduction  of  the  fac- 
tory system.  In  addition  to  the  new  methods  of  manufacture 
there  were  wars,  peculiar  conditions  in  land  ownership,  duties, 
and  taxes.  There  is  some  evidence  that  the  condition  of  child 
workers  under  the  domestic  system  was  often  worse  than  in 
the   factories,  their  parents  proving  the  hardest  taskmasters, 

"The  evils  and  horrors  of  the  industrial  revolution  are  often  vaguely 
ascribed  to  the  'transition  stage'  brought  about  by  the  development  of  ma- 
chinery and  the  consequent  'upheaval.'  But  the  more  we  look  into  the 
matter,  the  more  convinced  we  become  that  the  factory  system  and  machin- 
ery merely  took  what  they  found,  and  that  the  lines  on  which  the  industrial 
revolution  actually  worked  itself  out  cannot  be  explained  by  the  progress  of 
material  civilization  alone ;  rather,  the  disregard  of  child-life,  the  greed  of 
child-labour,  and  the  maladministration  of  the  poor  law  had,  during  the 
eighteenth  century,  and  probably  much  farther  back  still,  been  preparing 
the  human  material  that  was  to  be  so  mercilessly  exploited."  l 

But  whatever  the  causes,  the  facts  that  have  been  revealed  re- 
garding the  conditions  in  English  mines  and  factories  of  this 
period  are  amazing.  The  picture  includes  cruelty  to  appren- 
tice children,  excessive  hours,  and  unheal thful  conditions  of 
work.  The  evils  were  worst  in  the  smaller  factories,  the 
owners  of  which  were  hard  pressed  by  relentless  competition. 
Outside  of  the  factories,  also,  those  who  attempted  to  continue 
to  work  in  their  homes  in  the  old  way  suffered  from  irregular 
employment  and  low  earnings.  The  distress  of  the  hand-loom 
weavers  affords  an  illustration. 

Competition  and  Laissez-faire.  —  We  have  seen  that  Adam 
Smith  advocated  liberty.  He  asserted  that  every  man,  it 
allowed  to  do  as  he  pleased,  would  sooner  or  later  do  that  for 
which  he  was  best  fitted,  and  would  consequently  work  where 
he  could  get  the  most  wages.  Every  man  would  buy  what 
suited  him  best,  and,  after  some  experiments,  manufacturers 
would  make  what  was  called  for.  If  one  line  of  work  was  more 
profitable  than  another,  more  men  would  go  into  it  and  by  their 
competition  would  bring  prices  down.  If  men  cheated  their 
customers,  the  customers  would   go  elsewhere,  and  cheating 

1  Hutchins  and  Harrison,  A  History  of  Factory  Legislation,  p.  13. 


54  OUTLINES  OF  ECONOMICS 

would  not  pay.  Everywhere  men  would  look  out  for  their 
own  interests  and  would  make  the  bargain  that  was  most  ad- 
vantageous to  themselves.  This  system  of  balanced  self- 
interests  resulting  from  competition  was  the  best  regulator 
possible,  infinitely  better,  he  claimed,  than  the  old-time  laws, 
which  only  incumbered  the  development  of  industry.  If  the 
policy  of  industrial  freedom  were  adopted,  there  would  be,  he 
prophesied,  a  great  increase  in  the  production  of  wealth. 

This  view  gained  favor  during  the  Industrial  Revolution. 
Not  that  a  wholesale  repeal  of  the  old  laws  occurred  —  such  things 
never  happen  in  England,  and  are  difficult  anywhere  —  but 
there  is  a  quiet  and  effective  way  of  changing  laws  by  changing 
men's  ideas  regarding  them  and  leaving  them  unenforced. 
A  law  that  has  been  long  observed  has  often  to  be  long  dead 
before  people  gain  the  courage  to  repeal  it.  So  the  law  requiring 
seven  years'  apprenticeship  before  one  could  enter  certain 
trades  quietly  died  during  the  eighteenth  century,  and  when, 
finally,  in  the  labor  troubles  early  in  the  nineteenth  century 
some  workmen  discovered  the  old  law  and  prosecuted  employers 
for  violating  it,  it  was  first  suspended  and  then  repealed,  as  being 
plainly  ill  adapted  to  the  new  condition  of  industry.  So,  little 
by  little,  the  old  laws  were  repealed  or  forgotten,  and  men  were 
left  free  to  bargain  and  manufacture  as  they  pleased. 

This  policy  of  laissez-faire,  or  letting  things  drift,  was  very 
generally  accepted  by  the  economic  writers  who  followed  Adam 
Smith,  and  was  clearly  reflected  in  the  parliamentary  debates. 
The  universal  free  play  of  competition  came  to  be  the  pre- 
vailing ideal  in  this  first  phase  of  the  industrial  stage.  It  was 
in  keeping  with  this  spirit  that  England  became  a  free-trade 
nation  in  this  period,  the  last  step  being  taken  when  the  "  corn 
laws  "  were  repealed  in  1846,  the  act  going  into  effect  in  1849. 

The  Reaction  against  the  Passive  Policy.  —  It  may  be  said 
that  by  1850  the  abandonment  of  mercantilistic  ideas  was  com- 
plete in  England,  but  long  before  this  date  a  new  system  of 
legislation  for  the  purpose  of  controlling  industry  had  been 
begun.  The  government  could  not  ignore  the  actual  condi- 
tions that  resulted  from  competition  and  the  introduction  of 


THE  EVOLUTIuN   OF  ECONOMIC  SOCIETY  55 

machinery.    We  have  now  to  consider  some  of  the  main  lines 
of  development  of  this  modern  industrial  regulation. 

1.  The  Quality  of  Goods.  —  In  repealing  the  laws  for  the  in- 
spection of  wares  it  was  urged  that  cheating  would  not  pay 
and  would  cure  itself.  Indeed,  it  was  said  that  the  very  in- 
spection of  wares  by  the  government  was  the  cause  of  fraud ; 
for,  the  government  brand  being  often  put  on  carelessly,  men 
bought  poor  goods,  because  of  the  brand,  which  they  would 
have  rejected  if  they  had  examined  them.  The  abolition  of 
the  laws  would  result  in  each  examining  goods  for  himself,  it 
was  asserted.  It  is  hardly  necessary  to  say  that  these  hopes 
were  not  realized.  Men  might  be  trusted  to  attend  to  their  own 
interests  if  they  knew  enough  to  do  so,  but  they  do  not.  Who 
can  tell  the  quality  of  baking  powder,  or  ground  spices,  or 
patent  medicines,  or  many  other  things  that  are  misrepresented 
when  offered  for  sale?  For  these  the  ordinary  buyer's  knowl- 
edge is  worthless;  an  expert  must  be  employed.  Such  has 
been  the  experience  of  the  English  people  and  also,  more  re- 
cently, of  the  people  of  the  United  States,  and  the  law  now  pro- 
vides for  the  inspection  by  government  experts  of  many  articles 
of  food.  The  notion  that  men  will  always  ruin  their  business 
prospects  if  they  cheat,  and  so  will  be  deterred  from  cheating, 
has  been  utterly  exploded  by  this  English  experiment.  The  rep- 
utation for  honesty  is  undoubtedly  a  source  of  strength  to 
many  business  houses;  but  many  a  man  has  perpetrated  an 
audacious  fraud  upon  a  country  for  a  few  years  and  retired 
with  a  fortune  when  his  cheating  began  to  be  known.  The 
inspection  of  goods  by  the  State  is  a  principle  now  fully  rec- 
ognized, the  only  question  being  how  far  it  should  be  applied. 

2.  The  Protection  of  Labor.  — As  a  result  of  a  series  of  epi- 
demics of  infectious  fevers,  public  attention  was  called  to  the 
condition  of  the  apprenticed  children  in  cotton  factories.  In 
1796  the  Manchester  Board  of  Health  reported  upon  the  un- 
healthful  conditions  under  which  the  children  worked,  pointing 
out  that  "  the  untimely  labour  of  the  night,  and  the  protracted 
labour  of  the  day,  with  respect  to  children,  not  only  tends  to 
diminish  future  expectations  as  to  the  general  sum  of  life  and 


56  OUTLINES  OF  ECONOMICS 

industry  by  impairing  the  strength  and  destroying  the  vital 
stamina  of  the  rising  generation,  but  it  too  often  gives  encourage- 
ment to  idleness,  extravagance,  and  profligacy  in  the  parents, 
who,  contrary  to  the  order  of  nature,  subsist  by  the  oppression 
of  their  offspring."  In  1802  the  first  factory  act  was  passed  to 
protect  the  health  and  morals  of  pauper  children  in  cotton 
factories.  The  apprentices  were  not  to  work  more  than  twelve 
hours  by  day,  and  after  1804  not  at  all  by  night,  but  the  law 
was  not  effectively  administered.  After  much  agitation,  in 
which  Robert  Owen  took  a  prominent  part,  a  second  step  was 
taken  in  1819.  The  act  prohibited  children  under  nine  years 
from  working  in  cotton  mills,  and  no  person  under  sixteen 
was  to  be  employed  more  than  twelve  hours  per  day.  As  with 
the  act  of  1802,  the  enforcement  of  the  law  was  left  to  the  justices 
of  the  peace.  In  1833  regulations  as  to  conditions  of  work  for 
children  and  young  persons  were  made  for  all  textile  factories, 
and  special  inspectors  were  provided  to  enforce  the  law.  In 
the  following  years  the  controversy  concerning  labor  legislation 
was  violent  and  bitter.  After  a  report  by  a  committee  revealing 
shameful  conditions  in  the  mines,  an  act  was  passed  in  1842 
prohibiting  the  employment  of  women  and  children  under- 
ground. In  1844  women  were  included  in  the  protective  fac- 
tory legislation  and  the  half-time  system  for  children  was 
enacted.  The  Ten  Hours'  Act  of  1847  limited  the  working 
day  to  ten  hours.  Subsequently  protective  legislation  was 
made  to  cover  industrial  establishments  generally.  These 
various  laws  were  consolidated  in  1878,  and  again  in  1901. 

Another  important  line  of  legislation  that  has  been  made 
necessary  by  the  extensive  use  of  machinery  deals  with  the 
liability  of  employers  in  cases  of  accidents  to  their  workmen. 
Under  the  common  law  a  workman  was  entitled  to  receive  dam- 
ages when  injured  as  a  result  of  the  negligence  of  his  employers, 
but  he  was  supposed  to  assume  the  ordinary  risks  of  the  busi- 
ness. When  the  injury  was  caused  by  the  workman's  own  negli- 
gence or  by  the  negligence  of  a  fellow-workman  the  employer 
was  not  responsible.  The  Employers'  Liability  Act  of  1880 
gave  the  workman  the  right  to  compensation  in  certain  cases 


THE  EVOLUTION  OF  ECONOMIC  SOCIETY  57 

where  the  injury  was  caused  by  the  negligence  of  other  em- 
ployees, and  in  1897,  by  the  Workmen's  Compensation  Act,  a 
radical  departure  was  made  from  previous  legislation.  The 
employer  is  now  liable  to  pay  damages  even  when  there  has 
been  no  negligence  on  his  own  part,  and  even  when  the  accident 
has  been  due  to  the  neglect  of  the  injured  workman  himself, 
except  only  in  cases  of  "  serious  and  willful  misconduct."  This 
principle  now  applies  also  to  agriculture,  shipping,  and  mer- 
cantile and  domestic  employments,  and  certain  trade  diseases 
have  been  made  to  count  as  accidents.  The  transition  from 
"employers'  liability"  to  "workmen's  compensation"  was  thus 
a  change  in  more  than  mere  name.  The  law  of  employers' 
liability  aimed  merely  at  doing  justice  as  between  the  workman 
and  his  employer.  Workmen's  compensation  statutes  are 
based  upon  a  broader  social  principle,  involving  the  recognition 
of  the  facts  that  industrial  accidents  are  part  of  the  price  that 
has  to  be  paid  for  the  use  of  modern  methods  of  production ; 
that  the  worker  and  his  family  are  ill-equipped  to  bear  the  burden 
of  the  loss  of  earning-power  that  results  from  such  accidents; 
and  that  the  duty  of  making  adequate  compensation  falls  upon 
society  at  large,  which  may  very  properly  use  the  employer 
as  its  responsible  agent  for  this  purpose. 

A  newer  and  larger  development  of  the  principle  of  compensa- 
tion is  found  in  social  insurance,  which  recognizes  and  extends 
the  principle  of  social  responsibility,  but  combines  with  it  an 
insistence  upon  the  equal  importance  of  the  development  of 
habits  of  individual  thrift  and  self-help.  The  National  In- 
surance Act  of  191 1  provided  for  compulsory  insurance  against 
sickness,  and  (in  certain  industries)  against  unemployment. 

3.  Labor  Organizations.  —  Modifications  in  the  working  of  free 
competition  have  also  been  effected  by  the  voluntary  organiza- 
tions of  the  workers,  not  only  by  their  influence  upon  legislation , 
but  also  by  direct  dealings  with  employers.  We  have  noticed 
the  gilds,  which  played  a  large  part  in  the  history  of  the  Middle 
Ages.  These,  however,  were  not  like  modern  trades  unions. 
They  were  unions  of  men  who  worked,  but  not  exclusively  of 
wage  earners,  nor  even  chiefly  in  the  interests  of  wage  earners. 


58  OUTLINES  OF  ECONOMICS 

They  were  formed  of  masters.  But  combinations  of  the  wage- 
earning  classes  are  found  long  before  the  Industrial  Revolution. 
They  do  not  become  prominent,  however,  until  the  nineteenth 
century.  Laws  prohibiting  the  combination  of  laborers  had 
been  passed  at  intervals  since  the  Middle  Ages,  and  in  1800 
Parliament,  finding  that  unions  were  increasing,  passed  a  most 
comprehensive  law  to  suppress  them,  declaring  illegal  "  all 
agreements  between  journeymen  and  workmen  fcr  obtaining 
advances  of  wages,  reductions  of  hours  of  labor,  or  any  other 
changes  in  the  conditions  of  work."  Under  this  law  many 
workmen  were  prosecuted  and  severely  punished,  but  in  vain. 
In  1824  Parliament  confessed  the  law  a  mistake,  and  repealed 
it  along  with  previous  laws  relating  to  combinations  of  work- 
men. Trades  unions,  thus  tolerated,  grew  at  an  astonishing 
rate,  but  they  were  still  subject  to  legal  persecution.  Judicial 
decisions,  especially,  were  adverse  to  them,  as  the  courts  re- 
garded them  as  agreements  in  restraint  of  trade.  But  in  187 1 
a  law  was  passed  which  declared  that  the  purposes  and  actions 
of  trades  unions  were  not  to  be  deemed  unlawful  as  being  in  the 
restraint  of  trade,  and  in  1875  the  legality  of  trades  unions  was 
still  further  recognized  by  the  provision  that  acts  which  were 
not  punishable  as  crimes  when  done  by  one  person  should  not 
be  indictable  as  conspiracy  when  done  by  two  or  more  in  further- 
ance of  trade  disputes,  and  finally,  in  1006,  the  courts  were 
forbidden  to  entertain  actions  for  damages  against  trades  unions. 
In  this  same  year  peaceful  picketing  was  legalized. 

4.  The  Extension  of  Government  Enterprise.  —  The  reaction 
against  a  laissez-faire  policy  is  further  shown  by  a  growth  in  the 
sphere  of  industry  directly  managed  by  the  government.  We 
find  municipalities  operating  street  railways  and  furnishing 
water,  gas,  and  electric  light.  Municipal  enterprise  includes 
also  in  various  places  markets,  docks,  dwellings,  baths,  race 
courses,  oyster  fisheries,  slaughterhouses,  milk  depots,  employ- 
ment bureaus,  sewage  farms,  theaters,  and  many  other  lines  of 
activity.  The  national  government  conducts  the  postal  sav- 
ings banks,  the  parcels  post,  and  the  telegraph  and  telephone 
systems. 


THE  EVOLUTION  OF   ECONOMIC   SOCIETY  59 

Summary.  —  In  this  chapter  a  brief  sketch  has  been  given  of 
England's  attempt  to  deal  with  a  new  set  of  forces.  An  im- 
mense increase  in  production  has  taken  place,  due  in  part  to 
competition,  more  to  machinery.  But  the  distribution  of  this 
wealth,  growing  directly  out  of  the  principles  of  competition  so 
long  as  they  were  unrestrictedly  applied,  was  such  that  poverty 
grew  rapidly,  and  some  said  even  faster  than  wealth,  and  the 
laboring  population  of  the  realm  sank  into  deeper  distress  and 
degradation.  The  partial  benevolence  of  employers,  which 
would  fain  have  mitigated  this  disaster,  was,  as  a  rule,  neither 
welcome  nor  tolerated  by  the  competition  which  had  made  itself 
law.  Not  until  this  benevolence  was  formulated,  generalized, 
and  enforced  by  disinterested  legislation  was  the  horror  of  the 
situation  diminished.  When  we  hear  the  principle  of  "  a  fair 
field  and  no  favor  "  and  "  no  State  intervention  "  advocated  by 
a  man  strong  in  the  consciousness  of  personal  advantages,  we 
must  remember  that  he  is  a  century  behind  his  time,  and  that 
he  has  not  read  or  has  not  profited  by  one  of  the  most  dolorous 
chapters  in  human  history.  The  English  nation,  after  a  trial 
of  free  competition  and  no  interference,  as  thorough  as  could 
well  be  made,  has  undeniably  returned  to  the  principle  of  govern- 
mental activity  which  she  had  abandoned,  —  a  principle  which 
recognizes  as  the  function  of  the  State  the  protection  of  the 
citizens,  and  the  furtherance  of  their  material  and  social  well- 
being,  by  every  law  and  every  activity  which  offers  a  reasonable 
guarantee  of  contributing  to  that  end.  It  is  to  be  noticed  fur- 
thermore that,  as  a  matter  of  fact  all  this  activity  of  the  State 
contributing  to  material  and  social  well-being  has  also  increased 
freedom  as  a  positive,  constructive  force.  It  has  promoted 
the  growth  of  individual  powers  and  enlarged  the  scope  of  activity 
of  the  average  citizen.  It  has  not  tended  to  slavery,  as  Herbert 
Spencer  long  ago  maintained,  but  its  tendency  has  been  in  the 
direction  of  the  sort  of  liberty  that  is  really  worth  while  ;  namely, 
liberty  as  a  power  of  development  and  of  contributing  (in  the 
words  of  the  philosopher  T.  H.  Green)  to  the  "  common  good." 
The  older  legislation  restricted  the  individual ;  the  newer  legis- 
lation enlarges  and  equalizes  opportunities. 


6p  OUTLINES  OF  ECONOMICS 

QUESTIONS  AND  EXERCISES 

i.   What  is  the  origin  of  the  term  "laissez-faire"? 

2.  What  laws  are  in  force  in  your  state  regarding  the  inspection  of  food 
and  other  articles  offered  for  sale? 

3.  Give  a  detailed  account  of  the  development  of  one  of  the  great  inven- 
tions. 

4.  Give  a  sketch  of  the  enactment  and  repeal  of  the  "corn  laws." 

5.  Give  an  account  of  the  development  of  monopolies  and  trusts  in 
England. 

REFERENCES 

Ashley,  W.  J.     Economic  Organization  of  England,  Chaps,  vii  and  viii. 

Beard,  C.  A.     The  Industrial  Revolution. 

Cheyney,  E.  P.  Industrial  and  Social  History  of  England,  Chaps,  viii 
and  ix. 

Cunningham,  William.  Growth  of  English  Industry  and  Commerce,  Mod- 
ern Times,  Part  ii,  Laissez-Faire. 

Day,  Clive.     History  of  Commerce,  Part  iii. 

Hobson,  J.  A.     Evolution  of  Modern  Capitalism,  Chaps,  iii  and  iv. 

Hutchins,  B.  L.,  and  Harrison,  A.  A  History  of  Factory  Legislation, 
Chap.  ii. 

Perris,  G.  H.     The  Industrial  History  of  Modern  England. 

Slater,  Gilbert.  The  Making  of  Modern  England;  Tlie  English  Peasantry 
and  the  Enclosure  of  Common  Fields. 

Toynbee,  Arnold.     The  Industrial  Revolution. 

Veblen,  Thorstein.     The  Instinct  of  Workmanship,  Chaps,  vi  and  vii. 

Warner,  G.  T.    Landmarks  in  English  Industrial  History. 


CHAPTER  V 

THE    ECONOMIC    DEVELOPMENT    OF    THE    UNITED 

STATES 

Economic    Stages    in    American    Industrial    History.  —  The 

transit  of  civilization  from  Europe  to  America,  as  an  American 
historian x  has  finely  phrased  it,  thrust  the  European  laws, 
customs,  and  industrial  technique  of  the  seventeenth  century 
into  the  primitive  environment  of  a  wilderness,  and  for  the 
moment  the  wilderness  dominated.  Industry  was  forced  to 
begin  at  the  beginning  and  retrace  —  as  the  child  is  said  to 
retrace  the  mental  development  of  mankind  —  the  industrial 
evolution  of  the  race. 

The  American  people  have  thus,  during  the  comparatively 
brief  historical  period  which  has  elapsed  since  the  settlement 
of  this  country,  run  the  whole  gamut  of  industrial  evolution, 
passing  with  striking  rapidity  through  all  the  stages  differen- 
tiated in  the  preceding  chapters.  There  was  slaughter  of  cap- 
tives in  the  Indian  wars,  enslavement  of  Indians,  particularly 
—  but  not  only  —  in  the  Spanish  colonies,  later  the  introduction 
of  negro  slavery  and  modified  serfdom  in  the  indentured  servants, 
then  the  individual  wage  contract,  still  supreme  among  agri- 
cultural laborers,  and  finally,  collective  bargaining  through 
the  great  trades  unions  of  the  present.  In  a  similar  way, 
practically  all  the  stages  differentiated  in  the  table  given  on 
page  45  may  be  traced  in  the  industrial  evolution  of  the  United 
States. 

Naturally  it  is  not  to  be  supposed  that  American  industrial 
society  worked  its  own  way  unaided  through  all  those  economic- 
stages  which  the  race,  with  "  painful  steps  and  slow,"  has  labori- 
ously traversed  in  its  upward  march.     Stimulated  by  European 

1  Edward  Eggleston,  Transit  of  Civilization. 
6r 


62  OUTLINES  OF  ECONOMICS 

culture,  we  hurried  through  the  earlier  stages,  for  the  most 
part,  retracing  them  merely  as  an  incident  of  frontier  conditions, 
and  skipping  some  —  such  as  the  pastoral  stage  —  in  many 
sections  of  the  country.  On  the  other  hand,  it  must  not  be 
inferred  that  we  have  everywhere  passed  beyond  the  so-called 
primitive  stages.  Barter  may  still  be  found  in  some  parts  of 
the  country,  and  there  are  comparatively  few  rural  districts 
in  which  credit  transactions  have  in  the  main  taken  the  place 
of  money  transactions.  It  is  interesting  to  observe  that,  owing 
to  the  progressive  western  movement  of  the  population  of 
the  country,  the  stages  in  the  history  of  man's  productive  efforts 
appeared  in  regular  order  from  west  to  east.  Thus,  a  few 
years  ago,  the  country  of  the  frontier  was  occupied  by  hunters 
and  trappers;  next  were  great  stretches  of  country  almost 
entirely  devoted  to  grazing;  farther  east,  agriculture  pre- 
dominated ;  trade  and  commerce  were  active,  especially  in  the 
country  east  of  the  Mississippi ;  manufacture  on  a  large  scale 
was  prominent  in  the  North  Atlantic  and  North  Central  groups 
of  states ;  while  finally  the  large  industrial  combinations  which 
mark  the  latest  step  in  development  were  confined  (with  respect 
to  legal  residence  at  least)  to  the  Atlantic  seaboard.  "  The 
United  States  lies  like  a  huge  page  in  the  history  of  society."1 
Sectionalism.  —  This  phenomenon  of  the  contemporaneous 
existence  of  several  industrial  stages,  side  by  side,  under  the 
same  government,  has  laid  upon  this  country  some  of  the  hardest 
problems  which  it  has  had  to  solve.  The  ever  present  but 
ever  receding  frontier  has  continually  created  a  set  of  interest? 
antagonistic  to  those  of  the  settled  industrial  and  commercial 
communities.  Shays's  Rebellion  in  1786  was  in  part  a  protest 
of  the  more  thinly  settled  debtor  communities  against  the  deter- 
mination of  the  commercial  centers  to  introduce  the  sound 
currency  which  a  developed  commerce  requires.  The  federal 
Constitution  was  adopted  and  the  present  government  created 
in  order,  largely,  to  strengthen  national  credit,  insure  taxation, 
remove  trade  barriers,  and  provide  a  sound  currency ;  and  the 
opposition  to  the  ratification  of  the  Constitution  came  largely 

1  F.  J.  Turner,  The  Significance  of  the  Frontier  in  A  mcrican  History. 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES     63 

from  those  agricultural  and  thinly  settled  communities  that 
wanted  to  keep  paper  money,  evade  debt  payment,  and  resist 
the  collection  of  taxes.  During  the  earlier  history  of  the  coun- 
try wildcat  banking  and  inflated  currency  regularly  followed  in 
the  wake  of  the  frontier. 

Tariff  legislation,  with  its  different  appeal  to  the  agricultural 
and  industrial  sections  of  the  country,  has  been  another  prolific 
source  of  territorial  conflict.  After  the  War  of  181 2,  the  manu- 
facturing centers  of  the  North  redoubled  their  efforts  for  pro- 
tection. This  was  strenuously  resisted  by  the  South,  where 
manufactures  had  practically  gained  no  hold,  and  the  struggle 
of  the  sections  over  the  tariff  led  to  Nullification  in  South  Caro- 
lina and  the  acceptance  by  the  South  of  the  doctrine  of  secession. 
The  Civil  War  itself  was  largely  a  sectional  quarrel  growing  out 
of  ceaseless  friction  between  a  section  which  had  reached  the 
industrial  stage  and  a  condition  of  free-wage  contract  with  a 
section  which  had  been  held  in  the  agricultural  stage  by  the 
retention  of  slavery.  As  a  more  recent  illustration  of  sectional 
conflict  arising  from  the  natural  clash  of  districts  in  different 
stages  of  economic  development,  we  have  the  free-silver  cam- 
paign of  1896,  when  the  mining,  agricultural,  and  debtor  com- 
munities of  the  West  and  South  arrayed  themselves  against  the 
industrial  and  creditor  communities  of  the  East  and  North. 
The  typical  political  struggles  of  the  past  have  been  territorial, 
and  sectional  problems  will  always  remain.  Now  that  the 
frontier  has  disappeared,  however,  the  typical  political  struggles 
of  the  future  will  take  the  form,  probably,  of  class  against  class. 

Characteristics  of  the  American  People.  —  Although  the 
frontier  has  disappeared,  the  pioneer  work  of  "  winning  a  con- 
tinent from  nature  and  subduing  it  to  the  uses  of  man  "  has 
left  an  indelible  impress  upon  the  American  character.  In  the 
beginning  the  dangers  and  hardships  of  the  frontier  acted  as  a 
powerful  selective  force  in  determining  the  character  of  our 
earlier  immigrants,  giving  us  an  unusually  restless,  mobile,  and 
enterprising  people.  The  process  of  settlement  which  followed 
merely  emphasized  these  qualities  and  added  others  of  a  kindred 
nature.     The  primitive  settle'--  following  the  trapper  and  tire 


64  OUTLINES  OF  ECONOMICS 

trader  into  the  wilderness,  was  forced  to  depend  upon  himself 
for  protection  and  subsistence ;  he  expected  little  aid  from  the 
government,  was  unused  to  the  restraints  of  law,  and  a  little 
contemptuous  of  its  possibilities,  either  for  good  or  for  evil. 
The  process  of  settlement,  then,  merely  confirmed  the  American 
in  that  excessive  individualism  which  has  made  him  independent 
and  resourceful,  to  be  sure,  but  partial  to  the  spoils  system, 
tolerant  of  lynch  law  and  labor  violence,  indifferent  to  waste 
and  weakness  in  the  administration  of  his  government. 

At  the  same  time  the  great  natural  wealth  of  our  land  and  the 
ease  with  which  it  could  be  secured  from  the  government  have 
taught  our  people,  particularly  in  the  West,  to  regard  nature 
rather  than  thrift  as  the  source  of  wealth,  to  exploit  rather  than 
create,  to  work  and  study  as  we  farm,  —  extensively.  As  a 
people,  we  are  optimistic  but  careless,  generous  but  wasteful, 
buoyant  but  boastful.  Industrially,  we  have  risen  to  our  ex- 
ceptional opportunities  with  spirit,  playing  the  commercial  game 
at  times  with  excessive  energy  and  devotion ;  but  we  have  come 
to  emphasize  quantity  rather  than  quality,  product  rather  than 
finish.  We  "  lead  the  world "  in  the  use  of  labor-saving 
machinery,  but  depend  largely  upon  Europe  for  our  skilled 
artisans. 

Growth  of  Population.  —  The  mere  growth  of  the  American 
people  has  been  as  striking  as  it  is  familiar.  In  1640  there  were 
about  25,000  persons,  excluding  Indians,  in  British  North 
America ;  about  260,000  at  the  end  of  the  seventeenth  century 
according  to  Bancroft;  according  to  the  same  authority  the 
million  mark  was  reached  in  1743 ;  and  in  1790  the  first  federal 
census  showed  a  population  of  3,930,000  in  the  United  States 
alone.  In  the  next  hundred  years  the  population  doubled  every 
twenty-five  years  on  an  average,  and  although  the  rate  of  in- 
crease has  fallen  off  somewhat  since  the  Civil  War,  we  are  still 
growing  at  a  remarkable  pace,  the  population  of  continental 
United  States  being  91,970,000  in  1910. 

Despite  this  enormous  increase,  the  population  of  this  coun- 
try has  not  multiplied  more  rapidly  than  the  means  of  subsistence. 
This  does  not  mean  that  every  one  receives  enough  to  live  in 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      65 

comfort.  On  the  contrary,  great  masses  of  people  live  in 
poverty.  Neither  does  it  mean  that  society  as  a  whole  produces 
enough  to  support  every  one  in  comfort,  if  the  wealth  produced 
were  equitably  or  evenly  divided.  On  the  latter  point  there  is 
deep  difference  of  opinion.  But  with  respect  to  the  movement 
over  long  periods,  say  during  the  preceding  century,  there  can 
be  no  doubt  that  wages  and  real  income  have  risen,  not  without 
interruption,  but  with  comparative  steadiness. 

The  dismal  predictions  of  overpopulation  which  were  so 
common  in  the  first  half  of  the  nineteenth  century  have  been 
signally  discredited  as  practical  propositions  applicable  to  the 
American  people  of  this  epoch.  The  exploitation  of  national 
wealth,  the  improvement  of  business  organization,  and  the  inven- 
tion of  labor-saving  machinery  have  more  than  kept  pace  with 
the  population ;  and  it  appears  that  over  long  periods  prosperity 
and  high  wages  tend  to  depress  rather  than  to  raise  the  birth 
rate,  even  of  the  wage-earning  population.  We  are  in  no  danger 
of  a  "  devastating  torrent  of  children." 

On  the  contrary,  the  real  problem  of  the  twentieth  century,  or 
at  least  the  problem  that  has  evoked  the  greatest  discussion,  is 
found  in  the  steady  decline  of  the  birth  rate.  According  to  some 
eminent  authorities,  the  race  is  dying  at  the  top,  the  ablest  and 
most  successful  people  have  the  smallest  families ;  and  this 
constant  sterilization  of  the  ablest  stock  is,  in  the  opinion  of 
such  authorities,  second  in  importance  to  no  problem  which 
Western  civilization  is  called  upon  to  solve.  It  is  not  that  we 
want  more  people.  Population  is  still  increasing  with  sufficient 
rapidity.  The  problem  lies  in  the  apparent  failure  of  the  most 
efficient  individuals  to  multiply  as  rapidly  as  certain  classes 
of  the  less  efficient.  Other  authorities,  it  should  be  added, 
maintain  that  this  "  race  suicide  "  has  been  going  on  for  cen- 
turies, that  it  has  not  in  the  past,  and  will  not  in  the  future, 
lower  the  vitality  or  general  efficiency  of  the  race.  Such  writers 
view  with  complacency  the  ceaseless  sterilization  of  the  upper 
classes,  maintaining  that  the  process  stimulates  the  ambition 
of  the  abler  members  of  the  lower  classes  by  creating  room  at  the 
top,  and  that  so  long  as  the  habits  and  ideals  of  the  upper  classes 


66  OUTLINES  OF  ECONOMICS 

remain  wholesome,  there  is  no  cause  for  regret  that  the  individ- 
uals who  compose  these  classes  are  not  self-perpetuating. 
Social  heredity,  not  personal  heredity,  the  preservation  of  sound 
morals,  wholesome  customs,  and  habits  of  social  helpfulness, 
together  with  the  opening  up  of  new  opportunities,  are  accord- 
ing to  these  writers  the  important  factors. 

Second  only  in  importance  to  "  race  suicide,"  and  intimately 
connected  with  it,  is  the  problem  created  by  the  rush  to  the  city. 
In  1790  about  33  Americans  in  every  thousand  lived  in  a  city  of 
8000  inhabitants  or  more,  in  1910  approximately  390  in  every 
thousand  lived  in  a  city  of  this  size.  The  mere  facts  in  this 
connection  are  familiar  to  every  one  and  need  no  elaboration. 
Their  importance  lies  in  the  fact  that  the  rush  to  the  city  is 
apparently  universal,  that  it  has  been  going  on  for  centuries, 
and  that  it  indefinitely  complicates  and  aggravates  the  social, 
industrial,  and  political  problems  of  our  time.  "  Race  suicide," 
for  example,  is  more  attributable  to  social  conditions  created 
by  city  life  than  to  any  physical  incapacity  of  the  women  of 
this  generation  to  bear  children ;  the  evils  commonly  charged 
to  the  factory  system  are  due  as  much  to  city  crowding  as  to 
the  factory  system  itself;  and,  speaking  generally,  whatever 
plan  of  reform  for  existing  evils  we  devise  or  champion,  we  must 
reckon  with  this  deep-rooted  and  persistent  force  which  draws 
to  the  city  so  much  of  the  best  talent  and  ability  which  the  rural 
districts  produce. 

Slavery  and  the  Negro  Problem.  —  From  the  earliest  period 
of  settlement,  one  of  our  fundamental  industrial  problems  has 
been  to  get  enough  labor  to  exploit  the  great  national  wealth  of 
the  country.  The  first  solution  attempted  was  by  importing 
bondsmen  or  indentured  servants.  "  Nearly  all  the  immigrants 
that  came  (to  Virginia)  between  1620  and  1650  were  bondsmen," 
and  in  1680  an  English  official  estimated  that  about  10,000 
persons  were  kidnaped  or  "  spirited  away  "  to  America  every 
year.  This  class  of  indentured  servants  consisted  of  runaway 
apprentices,  penniless  debtors,  kidnaped  children,  honest 
laborers,  vagrants,  and  criminals  of  all  kinds.  They  were  some- 
times subject  to  the  most  inhuman  treatment,  but,  because 


ECONOMIC  DEVELOPMENT  OF  THE   UNITED   STATES      67 

they  had  white  skins,  soon  melted  into  the  free  population  and 
never  created  a  race  problem. 

The  first  negro  slave  landed  in  Virginia  in  1619.  For  about 
thirty  years  they  did  not  increase  very  rapidly,  but  after  that, 
and  until  the  close  of  the  eighteenth  century,  they  multiplied 
with  greater  rapidity  than  the  white  population.  In  1790  there 
were  750,000  negroes  or  persons  of  negro  descent  in  this  country, 
constituting  19  per  cent  of  the  population.  Since  1790  the 
negro  population  has  steadily  declined  in  relative  importance, 
and  in  1910,  numbering  9,830,000  in  all,  it  constituted  only  11 
per  cent  of  the  general  population.  The  relative  decline  of  the 
negro  population  is  probably  not  due  to  white  immigration, 
since  the  natural  growth  of  the  white  population  is  markedly 
greater  than  that  of  the  negroes  in  the  South,  where  white 
immigration  has  been  unimportant.  The  whites  have  increased 
faster  than  the  negroes  even  in  those  countries  in  which  the 
negroes  greatly  outnumber  the  whites.1 

The  negro  problem  to-day,  so  far  as  it  is  an  economic  problem, 
arises  largely  from  the  ignorance  and  economic  weakness  of 
the  negroes  and  the  exploitation  to  which  their  ignorance  and 
weakness  subject  them;  from  their  concentration  in  certain 
narrow  districts  of  the  South,  known  as  black  belts;  their 
dependence  upon  credit  advances;  their  inability  readily  to 
take  up  diversified  farming  and,  outside  of  the  farming  dis- 
tricts, from  the  social  pressure  which  confines  them  to  a  relatively 
few  occupations,  most  of  which  —  particularly  as  they  practice 
them  —  are  neither  uplifting  nor  developmental.  In  1900,  for 
instance,  63  per  cent  of  the  male  and  90  per  cent  of  the  female 
negro  breadwinners  were  employed  in  unskilled  trades. 

This  condition  of  affairs  is  due  in  some  degree  to  the  economic 
inertia  and  shiftlessness  of  the  negroes  themselves.  Con- 
sidering the  circumstances  attendant  upon  their  introduction 
into  this  country,  it  would  be  surprising  if  they  were  not 
economically  backward.     But  present  conditions  are  also  due 

1The  greater  increase  of  the  whites  "holds  generally,  though  not  universally, 
good  in  even  the  most  overwhelmingly  black  of  the  black  counties  of  the  black  belt.': 
—  John  C.  Rose,  in  American  Economic  Review,  vol.  iv   d.  202. 


68  OUTLINES  OF  ECONOMICS 

in  part  to  race  prejudice  of  their  white  brethren.  There  is  a 
strong  movement  in  the  South  today  for  enforced  segregation 
of  negroes,  both  in  urban  and  rural  communities ;  and  the  trade 
unions  evince  a  growing  disinclination  to  receive  negroes  as 
members  on  the  same  status  as  white  workmen. 

Vigorous  efforts,  however,  are  now  being  made  in  the  South 
to  provide  industrial  training  of  a  systematic  kind  for  the 
negroes;  and  despite  the  asserted  facts  that  "  only  37  per  cent 
of  the  negro  school  population  of  the  South  is  in  school  attend- 
ance," that  "  in  the  rural  South  today  not  one  black  child  in 
four  is  in  school,"  and  that  "  the  public  school  system  for 
negroes  in  the  rural  South  is  worse  today  than  it  was  twenty 
years  ago,  with  a  smaller  percentage  of  enrollment  and  smaller 
proportion  of  teachers,"  1  the  economic  status  of  the  negro  in 
recent  years,  particularly  that  of  the  negro  farmer,  shows  steady 
improvement.  But  yesterday  a  slave,  it  is  inevitable  that  the 
negro  should  be  forced  to  traverse  in  the  forward  path  the 
intermediate  steps  of  serfdom,  peonage,  and  tenancy  before 
becoming  farm  operative  and  owner.  No  class  can  be  trans- 
formed in  a  day  by  legislative  enactment  from  the  status  of 
slavery  to  that  of  free  contract.  In  the  South  during  the  last 
census  decade  the  number  of  negro  farmers  increased  more 
rapidly  than  the  number  of  white  farmers ;  the  acreage  of  land 
operated  by  white  farmers  decreased  while  that  operated  by 
negro  farmers  increased  10  per  cent ;  the  value  of  farm  land 
and  buildings  owned  by  whites  increased  117  per  cent,  but  the 
value  of  farm  land  and  buildings  owned  by  negroes  increased 
156  per  cent ;  while  the  number  of  negro  farm  owners  increased 
17  per  cent  as  contrasted  with  an  increase  of  12  per  cent  in 
the  white  owners  of  farms.  The  negro  has  been  barred  from 
the  cotton  mill.  If  the  negro  farmer  can  learn  to  raise  some- 
thing other  than  cotton  and  raise  it  on  something  other  than 
credit,  he  will  probably  have  little  cause  to  regret  his  exclusion 
from  the  cotton  mill. 

Immigration.  —  Next  in  importance  to  the  negro  question  is 

1 W.  E.  B.  Du  Bois,  Quarterly  Publications  of  the  American  Statistical  Association, 
vol.  xiii,  p.  83. 


ECONOMIC   DEVELOPMENT  OF  THE   UNITED   STATES     69 

the  problem  of  immigration.  We  have  always  had  an  immigra- 
tion problem.  "  Governor  Thomas  Dongan,  in  1685,  made  a 
report  to  the  King  of  England  full  of  dreadful  forebodings  as 
to  the  future  of  the  '  Royal  Province  '  of  New  England  unless 
the  tendency  to  overcrowding  were  promptly  checked.  .  .  . 
George  Washington  and  Thomas  Jefferson  are  both  recorded 
as  opponents  of  an  unrestricted  policy  of  immigration,  and  it 
may  be  safely  asserted  that  no  considerable  period  has  elapsed 
since  their  day  without  producing  eloquent  and  forceful  advo- 
cates of  a  rigid  restrictive  immigration  policy."  *  Owing,  how- 
ever, to  the  extraordinary  increase  of  immigrants  in  recent  years 
(the  number  rose  from  3,840,000  in  the  decade  ending  in  1900 
to  8,796,000  in  the  decade  ending  in  1910)  unusual  interest  in 
the  subject  has  been  aroused,  the  restrictive  features  of  our  law 
have  been  repeatedly  strengthened,  and  on  three  occasions  bills 
aiming  to  restrict  the  general  volume  of  immigration  by  literacy 
tests  have  passed  Congress  only  to  be  vetoed  by  the  President. 
Most  of  the  alarm  which  has  recently  been  expressed,  however, 
is  due  to  the  change  in  character,  rather  than  the  increase  in 
volume,  of  our  immigration.  Instructive  statistics  bearing 
upon  this  point  are  given  in  Table  I.  Until  nearly  the  last 
decade  of  the  nineteenth  century  most  of  the  immigrants  came 
from  the  United  Kingdom,  Germany,  and  northwestern  Europe, 
while  since  that  time  the  arrivals  have  been  largely  from  south- 
ern Europe ;  and  it  appears  that  the  new  immigrants  are  more 
illiterate,  much  less  likely  to  bring  over  their  families  and  to 
remain  permanently  in  this  country,  display  less  interest  in 
taking  out  naturalization  papers,  and  show  a  larger  proportion 
of  unskilled,  as  well  as  a  smaller  proportion  of  skilled  laborers, 
than  the  earlier  immigrants.  "  These  people,"  it  has  been  said, 
"  have  no  history  behind  them  which  is  of  a  nature  to  give  en- 
couragement. They  have  none  of  the  inherited  instincts  and 
tendencies  which  made  it  comparatively  easy  to  deal  with  the 
immigration  of  the  earlier  time.  They  are  beaten  men  from 
beaten  races,  representing  the  worst  failures  in  the  struggle 

1  Commissioner  of  Immigration,  Robert  Watchorn,  in  The  Outlook,  vol.  kxxvii, 
p.  000. 


7o 


OUTLINES  OF  ECONOMICS 


TABLE  I 

Total  Number  of  Immigrants  (in  Thousands)  and  Proportion  coming 
from  Designated  Countries  by  Specified  Periods:  1821-1910  * 


1821 

1850 

1851 

i860 

1861 
1870 

1871 
1880 

1881 

1890 

1891 

1900 

1901 
1910 

Total  Number 

2456 

2598 

2315 

2812 

5247 

3844 

8795 

Per  cent 
Germany 

24.2 
150 
42-3 

0.7 

36.6 

16.3 

35-2 
0.9 

34-o 
26.2 
18.8 

5-4 

25.6 
19-5 

15-5 
8.6 

27.7 

15-4 
12.5 

12.5 

14.1 

8.9 

10.5 
9.9 

3-9 
6.0 
3-8 

5-7 

Great  Britain 

Ireland 

Norway,  Sweden,  and 
Denmark 

Total 

Austria  Hungary 

Italy   

82.2 
0.2 

O.I 

89.0 

°-3 
0.1 

84.4 

0.4 

0.5 

0.2 

69.2 

2.6 
2.0 
1.8 

68.1 

6.7 
5-9 
5-o 

43-4 

15-5 
17.1 

15-4 

19.4 

24.4 

233 
18.2 

Russia  and  Poland. . . . 

Total 
All  other  Countries  . .  . 
Grand  Total 

o-3 

i7-5 
100.0 

0.4 

10.6 

100.0 

I.I 

14-5 
100.0 

6.4 

24.4 

100.0 

17.6 

14-3 
100.0 

48.0 

8.6 

100.0 

659 

14.7 

100.0 

for  existence.     Centuries  are  against  them,  as  centuries  were 
on  the  side  of  those  who  formerly  came  to  us."  2 

There  can  be  no  doubt  about  the  real  gravity  of  the  problem. 
In  times  past  charitable  associations,  and  even  certain  foreign 
governments,   "  assisted  "   the  poorest  and  neediest  of  their, 

>Data  from  Adams  and  Sumner,  Labor  Problems,  p.  73,  and  the  Statistical 
Abstract,  1913,  p.  94.  These  figures  are  not  exact  and  not  altogether  comparable, 
owing  to  changes  in  the  immigration  year,  the  distinction  of  nationalities,  and  the 
immigration  laws.  For  the  effect  of  these  changes,  see  Boeckh,  "  The  Determina- 
tion of  Racial  Stock  among  American  Immigrants,"  Publications  of  the  American 
Statistical  Association,  December,  1906;  and  Willcox,  National  Civic  Federation 
Review,  November,  December,  1906,  p.  7.  In  the  year  ended  June  30,  1914,  the 
number  of  immigrants  (1,220,000)  was  larger  than  in  any  previous  year  except 
1907,  and  Austria-Hungary,  Italy,  and  Russia  contributed  67  per  cent  of  the  total. 

*  Walker,  "Restriction  of  Immigration,"  Discussions  in  Economics  and  Statistics, 
vol.  il  p.  447. 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      7 1 

TABLE  II 

Proportion  of  European  Immigrants  14  Years  of  Age  or  Over  Who 
can  neither  Read  nor  Write  :   1899-1909 l 

(Average  proportion  for  all  races,  26.6  per  cent.) 


Under  15  Per  Cent 

Over  15  Per  Cent 

Race 

Per  Cent 
Illiterate 

Race 

Per  Cent 
Illiterate 

Bohemian  and  Moravian 
Dutch  and  Flemish    .     . 

Italian,  North   .... 

Scandinavian     .... 
Scotch      

Welsh 

Not  specified     .... 

i-7 

4-7 

1.1 
1.4 

5-4 

5-i 

2.7 

11.8 

11.4 

0.4 

0.7 

14.6 

2.0 

6.7 

Armenian        

Bulgarian,    Servian,    and 

Montenegrin  .... 
Croatian  and  Slovenian  . 
Dalmatian,  Bosnian,  and 

Herzegovinian      .     .     . 

Italian,  South      .... 

Lithuanian 

Polish 

Ruthenian 

Turkish 

24.1 
41.8 

36-4 

36.4 

27.0 

25-7 
54-2 
48.8 

35-4 
68.2 

34-7 
38.5 
51.0 
22.1 
54-i 
S8.9 

citizens  to  migrate  to  this  country;  famine  and  revolution  in 
Europe  spurred  the  impecunious  and  the  radical  to  take  refuge 
among  us;  regularly,  also,  the  tide  of  immigration  has  ebbed 
and  risen  in  close  correspondence  with  the  business  prosperity 
of  this  country,  artificially  swelling  our  laboring  population  in 
times  of  industrial  activity,  encouraging  our  industrial  managers 
in  their  spasmodic,  jerky  methods  of  production,  and  thus 
augmenting  the  severity  of  our  alternating  periods  of  industrial 
depression.  Moreover,  in  certain  industries  the  immigrant 
with  his  relatively  low  standard  of  living  has  driven  out  the 
native  workman ;  and  most  of  the  immigrants  have  shown  an 
unfortunate  tendency  to  linger  in  the  cities  of  the  eastern  sea- 


Data  from  Jenks  and  Lauck,  The  Immigration  Problem,  3d  ed.,  p.  35- 


72  OUTLINES  OF   ECONOMICS 

board,  swarming  in  the  slums  and  intensifying  all  those  social 
evils  which  have  their  origin  in  urban  congestion. 

The  problem  is  chiefly  economic,  and  the  social  or  moral 
delinquencies  of  the  newer  immigrants  have  been  greatly  exag- 
gerated. Thus,  the  new  immigrants  are  far  less  given  to  alco- 
holic excesses  than  the  old.  But  the  investigations  of  the  United 
States  Immigration  Commission,  to  quote  from  its  report, 
"  show  an  oversupply  of  unskilled  labor  in  the  industries  of  the 
country  as  a  whole,"  and  the  Commission  recommends  that 
"  a  sufficient  number  be  debarred  to  produce  a  marked  effect 
upon  the  present  supply  of  unskilled  labor."  "  As  far  as 
possible,"  the  report  continues,  "  the  aliens  excluded  should  be 
those  who  come  to  this  country  with  no  intention  to  become 
American  citizens  or  even  to  maintain  a  permanent  residence 
here.  ..."  A  majority  of  the  Commission  recommended  the 
literacy  test  as  the  "  most  feasible  single  method  "  of  properly 
restricting  immigration ;  realizing  that  it  would  cause  occa- 
sional hardship  —  as  any  standard  must  —  and  that  not 
all  literate  immigrants  are  desirable,  and  not  all  illiterate  immi- 
grants undesirable ;  but  favoring  it  because  it  offers  a  practicable 
and  simple  means  by  which  to  reduce  numbers  without  impairing 
quality  or  discriminating  against  particular  nationalities.  Not 
in  individual  cases,  but  in  the  net  result,  the  literacy  test  would 
debar  those  classes  which  exploit  America  rather  than  strengthen 
it,  and  fail  to  rise  to  its  real  opportunities  and  responsibilities. 
Back  of  the  demand  for  restriction  is  not  the  "  American  " 
snob,  but  the  trade  union. 

In  the  light  of  history,  on  the  other  hand,  the  immigration 
problem  is  far  less  alarming  than  it  is  in  the  dry  light  of  recent 
statistics.  In  the  first  place,  the  statistics  themselves,  as  ordi- 
narily published,  are  misleading,  because  they  take  no  account 
of  the  large  number  of  immigrants  who  return  to  Europe.  The 
most  recent  census  statistics  (1910)  indicate  that  about  "  two 
fifths  oi  the  immigrants  who  arrived  in  the  United  States  during 
the  decade  1900-1910  either  left  the  United  States  or  died  before 
the  end  of  the  decade."  In  the  second  place,  the  importance 
of  the  number  of  immigrants  depends  largely  upon  its  relation 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      73 

to  the  population  of  the  country ;  and  relatively  to  the  popula- 
tion immigration  seems  to  be  declining  rather  than  increasing. 
For  instance,  the  proportion  of  foreign  born  in  the  population 
has  varied  very  little  since  i860;  and  immigration  reckoned 
in  proportion  to  the  population  was  heavier  in  the  period  1850- 
1855  than  in  the  period  1 900-1 905.  In  the  next  place,  it  is  to 
be  noted  that  our  immigration  laws  regarding  the  exclusion  of 
diseased,  criminal,  immoral,  feeble-minded,  and  indigent  persons 
are  constantly  becoming  stricter  and  their  administration  more 
efficient.  In  addition  to  the  plainly  undesirable  classes  just 
noted,  Chinese  laborers  have  been  excluded  since  1882,  aliens 
under  contract  to  take  up  particular  work  since  1885,  and  an- 
archists since  1903.  Finally,  and  most  important,  perhaps, 
agencies  for  educating,  distributing,  and  Americanizing  the 
immigrants  have  multiplied  with  great  rapidity  in  recent  years. 
Social  settlements,  vocational  and  night  schools  have  under- 
taken the  work  of  educating  the  immigrant ;  many  important 
labor  unions  have  learned  to  organize  the  immigrants,  and  so 
make  of  them  allies  and  not  enemies  in  the  task  of  maintaining 
and  improving  conditions  of  employment;  federal  and  state 
bureaus  of  information  assist  in  the  proper  distribution  of  the 
immigrants,  and  public  employment  bureaus  in  finding  work 
for  them;  while  a  group  of  powerful  and  philanthropic  immi- 
grant aid  societies  like  the  Italian  Immigrant  Bureau  and  the 
Hebrew  Sheltering  and  Immigrant  Aid  Society  "  do  effective 
work  in  Americanizing  the  immigrant,  finding  employment  for 
him  at  good  wages,  overcoming  tendencies  toward  congestion, 
effecting  distribution,  and  promoting  acquisition  of  American 
standards  of  living  and  thinking."  : 

Surveying  the  whole  history  of  immigration,  three  general 
conclusions  may  be  drawn  which  must  be  fully  considered  by 
those  engaged  in  the  solution  of  the  present  problem. 

1 .  We  have,  as  a  people,  shown  a  marvelous  ability  to  assimi- 
late rapidly  people  of  diverse  races,  tongues,  and  religions,  amal- 
gamate them  and  stamp  them  with  the  characteristic  qualities 
of  the  American.     Even  at  the  close  of  the  eighteenth  century  5 

1  Max  J.  Kohler,  American  Economic  Review,  vol.  iv,  p.  107. 


74  OUTLINES  OF  ECONOMICS 

about  one  fifth  of  the  population  spoke  some  other  language 
than  English  as  their  mother  tongue,  and  probably  one  half  of 
the  population  were  of  other  than  Anglo-Saxon  blood.  The 
heterogeneous  character  of  the  population  is  illustrated  by  the 
fact  that  nine  of  the  men  most  prominent  in  the  early  history  of 
New  York  represented  as  many  different  nationalities. 

2.  We  have  failed,  however,  to  amalgamate  the  Negro  and 
the  Chinese ;  the  incidental  feature  of  a  dark  skin  creates  espe-t 
daily  difficult  problems;  and  it  is  this  fact  which  makes  it 
undesirable  that  Japanese,  Chinese,  or  Hindu  laborers  should 
settle  here  in  large  numbers,  particularly  in  separate  "  colonies." 
Despite  the  high  qualities  of  some  of  these  peoples,  it  is  con- 
ceivable that  they  might  come  to  this  country  in  sufficient 
numbers  to  create  a  problem  similar  in  character  and  gravity  to 
the  negro  problem ;  and  if  investigation  show  that  there  is  real 
probability  of  such  a  result,  they  should  be  excluded,  even  though 
the  danger  be  attributable  to  race  prejudice  of  the  natives  rather 
than  the  clannishness  and  exclusiveness  of  the  immigrants. 

3.  In  the  main,  however,  the  traditional  policy  of  this  country 
has  been  "  to  improve  rather  than  to  check  immigration," 
and  the  burden  of  proof  is  upon  those  persons  who  would  restrict 
immigration  by  arbitrarily  limiting  the  number  of  immigrants. 

Natural  Resources.  —  Next  to  the  character  of  the  people 
with  which  this  continent  has  been  stocked,  the  most  powerful 
factor  in  shaping  the  economic  development  of  the  United  States 
has  been  its  enormous  natural  wealth.  With  a  territory  (ex- 
cluding Alaska  and  our  insular  possessions)  more  than  three 
fourths  as  large  as  all  Europe,  indented,  particularly  on  the 
eastern  coast,  with  a  large  number  of  good  harbors,  intersected 
by  internal  waterways  that  make  communication  cheap  and 
easy,  endowed  with  water  power  that  in  the  opinion  of  one 
authority  is  probably  "  more  valuable  than  those  of  all  other 
lands  put  together,"  marked  by  every  variety  of  climate  and 
soil,  covered  in  many  places,  at  least  originally,  with  magnificent 
forests,  and  liberally  stocked  with  almost  every  variety  of 
mineral  wealth,  it  is  not  surprising  that  at  the  present  time  the 
United  States  "  leads  the  world  "  in  the  production  of  iron  and 


ECONOMIC  DEVELOPMENT  OF  THE  UNITED   STATES  75 

steel,  cotton,  coal,  copper,  gold,  silver,  dairy  products,  corn,  wheat, 
lead,  lumber,  tobacco,  petroleum,  and  hogs.  It  would  be  strange, 
indeed,  with  the  vast  mineral  and  agricultural  resources  at  our 
command,  if  we  did  not  "  lead  the  world  "  in  many  things. 

Public  Lands.  —  Of  our  2,973,000  square  miles  of  territory 
about  three  fourths  at  one  time  or  another  has  belonged  to 
the  central  government.  The  possession  of  this  vast  common 
treasure  by  the  United  States  has  played  an  important  part  in 
dignifying  and  strengthening  the  federal  government.  But  the 
lavish  alienation  of  the  public  lands  in  endowing  free  schools, 
subsidizing  railways  and  other  internal-improvement  com- 
panies, and  in  providing  free  homes  for  the  landless,  has  been 
an  even  more  potent  factor  in  hastening  our  economic  develop- 
ment; though  it  has  led,  as  has  been  said  with  some  justifi- 
cation, "  to  the  ravishment  rather  than  the  development  of  our 
natural  resources." 

Even  more  important  is  the  influence  which  "  free  land  " 
has  exerted  upon  the  wages  of  labor  and  the  distribution  of 
wealth  in  this  country.  While  it  was  not  until  the  passage  of 
the  Homestead  Act  in  1862  that  land  could  be  legally  acquired 
without  cost  by  simple  occupation  and  cultivation,  it  is  practi- 
cally true  to  say  that  from  the  seventeenth  century  until  a  few 
years  ago  any  enterprising  citizen  could,  by  the  exercise  of  a 
minimum  amount  of  industry  and  frugality,  secure  a  homestead 
large  enough  to  support  himself  and  family.  This  opportunity 
offered  to  the  artisan  a  free  choice  between  wage  service  and 
farming,  constantly  depleted  the  ranks  of  mere  laborers,  operated 
to  keep  wages  as  high  as  the  earnings  of  a  "  no-rent  "  homestead, 
and  kept  fresh  and  vigorous  that  feeling  of  independence  which 
has  been  the  distinguishing  mark  of  the  American  workingman. 
Up  to  June  30, 1909,  according  to  President  Van  Hise,  the  United 
States  had  sold  or  disposed  of  to  corporations  and  individuals 
571,600,000  acres;  it  had  granted  to  the  states  for  various 
purposes  153,500,000  acres ;  324,500,000  acres  had  been  reserved 
for  parks,  forests,  and  other  public  purposes ;  while  there  were 
363,300,000  acres  still  unreserved  and  unappropriated,  not 
counting  378,000,000  acres  in  Alaska,  of  which  all  but  about 


76  OUTLINES  OF  ECONOMICS 

10,000,000  acres  were  unappropriated  and  unreserved.  The 
lands  which  were  sold  brought  less  than  it  cost  to  acquire,  survey, 
and  carry  them.  At  the  date  mentioned  127,000,000  acres 
had  been  given  away  under  the  Homestead  and  Timber  Culture 
Acts — supposedly  to  actual  settlers  —  and  142,000,000  had 
been  given  to  corporations  to  stimulate  the  building  of  railroads 
and  other  internal  improvements.1 

How  long  the  public  lands  will  hold  out  it  is  impossible  to 
say.  Notwithstanding  the  fact  that  the  national  government 
is  disposing  of  its  lands  at  the  rate  of  from  fifteen  to  twenty 
million  acres  a  year,  there  is  still  left  —  if  we  count  Alaska  — 
almost  as  much  territory  as  we  have  alienated  since  the  adoption 
of  the  Constitution.  Most  of  this  is  worthless  or  unavailable ; 
but  irrigation  and  dry  farming  are  reclaiming  certain  districts. 

In  the  East,  especially,  we  have  almost  certainly  entered  upon 
a  new  era,  and  it  must  be  remembered  that  fifteen  sixteenths  of 
the  population  reside  in  the  eastern  half  of  the  United  States. 
East  of  the  Mississippi  trade  and  manufactures  taken  together 
have  outstripped  agriculture,  and  a  large  majority  of  the  people 
lack  the  inclination  and  necessary  training,  even  if  they  possessed 
the  courage  and  energy,  to  avail  themselves  of  possibly  cheaper 
lands  elsewhere.  Whatever  the  quality  of  this  cheap  land,  its 
importance  has  diminished  as  an  outlet  for  the  population  upon 
whose  economic  condition  it  formerly  exerted  so  salutary  an 
influence.  Considering  the  population  as  a  whole,  the  conclu- 
sion seems  irresistible  that  we  have  reached,  if  indeed  we  have 
not  already  passed,  the  parting  of  the  ways ;  and  the  assistance 
that  free  land  has  rendered  in  maintaining  wages  and  restrain- 
ing the  evil  tendencies  of  the  modern  system  of  capitalistic 
production  must  in  the  future  be  secured  from  other  sources. 
The  distinctive  Americanism  of  the  past  was  generated,  as  has 
been  said,  in  the  performance  of  our  national  task  "  of  winning 
a  continent  from  nature  and  subduing  it  to  the  uses  of  man  "  ;  * 
it  was  a  product  of  the  frontier.  But  the  frontier  has  now  dis- 
appeared. 

1  Charles  R.  Van  Hise,  The  Conservation  of  Natural  Resources  in  the  United  Ste*** 
p.  294.  *  E.  L.  Bogart,  Economic  History  of  the  United  States,  o.  i 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      77 

QUESTIONS 

1.  What  peculiar  characteristics  mark  the  economic  stages  of  the  United 
States? 

2.  Is  the  pastoral  stage  through  which  the  people  of  our  Great  Plains 
have  passed  essentially  different  from  the  pastoral  stage  through  which  the 
people  of  Israel  passed? 

3.  Enumerate  the  great  sectional  struggles  which  have  disturbed  the 
United  States.     Why  does  radicalism  accompany  the  frontier? 

4.  Has  the  frontier  and  the  work  of  settlement  left  a  permanent  impress 
upon  the  American  people  ?     Of  what  kind  ? 

5.  How  rapidly  is  the  population  increasing  at  the  present  time  ?  Are  the 
richer  or  poorer  classes  multiplying  more  rapidly?  Can  you  state  the 
reason  ? 

6.  What  are  the  distinctively  economic  factors  of  the  negro  problem? 

7.  When  did  the  immigration  problem  first  alarm  residents  of  this 
country?     What  charges  are  directed  against  the  "newer  immigrants"? 

8.  Have  we  shown  an  ability  to  assimilate  all  kinds  of  immigrants? 
What  has  been  the  historical  policy  of  this  country  toward  immigration? 

9.  What  part  did  the  public  domain  play  in  bringing  about  and  preserv- 
ing the  Union?  in  maintaining  wages? 

10.   How  does  the  growing  size  of  the  country  modify  the  influence 
exerted  by  free  land? 

REFERENCES 

Bogart,  E.  L.  Economic  History  of  the  United  States.  Contains  bibli- 
ography. 

Bruce,  P.  A.     Economic  History  of  Virginia  (2  volumes). 

Bureau  of  the  Census.     A  Century  of  Population  Growth. 

Callender,  G.  S.  Selections  from  the  Economic  History  of  the  United 
States. 

Com  an,  Katharine.  Industrial  History  of  the  United  States.  Contains 
bibliography. 

Economic  Beginnings  of  the  Far  West  (2  volumes). 

Commons,  J.  R.     Races  and  Immigrants  in  America. 

Emery,  H.  C.  "Economic  Development  of  the  United  States,"  in  The 
Cambridge  Modern  History,  Vol.  vii,  Chap,  xxiii. 

Fairchild,  H.  P.     Immigration. 

Hart,  A.  B.  (ed.)  The  American  Nation  (37  volumes).  Contains  chapters 
on  economic  history. 

Hourwich,  I.  A.     Immigration  and  Labor. 

Jenks,  J.  W.,  and  Lauck,  W.  J.     The  Immigration  Problem. 

McMaster,  J.  B.     A  History  of  the  People  of  the  United  Slates  (8  volumes). 

Ross,  E.  A.     The  Old  World  in  the  New. 

Semple,  E.  C.     American  History  and  its  Geographical  Conditions. 


78  OUTLINES  OF  ECONOMICS 

Simons,  A.  M.    Social  Forces  in  American  History. 

Turner,  F.  J.  "The  Significance  of  the  Frontier  in  American  History,"  in 
Bullock,  C.  J.,  Selected  Readings  in  Economics.  First  edition  in  Re- 
port of  the  American  Historical  Association,  1893. 

United  States  Immigration  Commission.  Reports  (39  volumes,  including 
useful  Abstracts  of  Reports,  in  2  volumes). 

Van  Hise,  C.  R.     The  Conservation  of  Natural  Resources  in  the  United  States. 

Weeden,  W.  B.    Economic  and  Social  History  of  New  England  (2  volumes). 

Welungton,  R.  G.  The  Political  and  Sectional  Influence  of  the  Public 
Lands. 


CHAPTER  VI 

I  THE    ECONOMIC    DEVELOPMENT    OF    THE    UNITED 
STATES  {Continued) 

In  the  preceding  chapter  attention  was  confined  to  certain 
fundamental  and  peculiarly  American  conditions  which  have 
influenced  the  economic  development  of  this  country.  They 
form  the  background  and  setting  of  the  picture.  When  we 
come  to  fill  in  the  details,  however,  the  general  effect  is  very 
similar  to  that  produced  by  the  description  of  English  'industrial 
development  given  in  Chapter  IV.  There  are  differences,  of 
course,  —  differences  important  enough  to  make  this  separate 
discussion  of  American  economic  evolution  necessary.  But, 
on  the  whole,  it  is  surprising  how  rapidly  we  have  developed 
the  industrial  maladies  and  economic  problems  of  the  Old 
World. 

Mercantilism  in  America.  —  In  the  American  colonies,  as  in 
England  itself,  the  Industrial  Revolution  was  preceded  by  a 
period  in  which  trade  and  industry  were  subject  to  minute  regu- 
lation by  the  government.  Bounties  were  freely  offered  in 
several  colonies  for  the  manufacture  of  leather,  iron,  paper, 
silk,  and  cloth ;  land  grants  were  made  and  taxes  remitted, 
particularly  in  the  support  of  the  iron  industry ;  and  in  order  to 
encourage  the  home  manufacture  of  shoes,  for  instance,  the 
General  Court  of  Massachusetts  in  1640  commanded  that 
every  hide  "  be  sent  to  a  tannery  under  penalty  of  a  £12  fine," 
while  "  leather  searchers  "  were  appointed  to  see  that  the  law 
was  obeyed. 

This  early  colonial  regulation  was  restrictive  as  well  as  protec- 
tive. In  the  New  England  colonies,  in  the  seventeenth  century, 
laws  were  repeatedly  passed  prohibiting  idleness,  fixing  the  hours 

70 


80  OUTLINES  OF  ECONOMICS 

of  labor,  and  prescribing  rates  of  wages,  with  appropriate  penal- 
ties for  workmen  who  took  or  employers  who  paid  more  than  the 
legal  rate.  In  the  Boston  Town  Records  of  1635,  for  instance, 
we  find  this  resolution :  "  That  Mr.  William  Hutchinson,  Mr. 
William  Colborne  and  Mr.  William  Breton  shall  sett  pryces 
upon  all  cattel,  comodities,  victuals  and  labourers  and  Work- 
men's Wages  and  that  noe  other  prises  or  rates  shal  be  given 
or  taken."  But  the  restrictive  laws,  in  general,  failed  dismally. 
The  abundance  of  cheap  land  and  the  independent  spirit  gener- 
ated by  the  pioneer  life  prevented  the  enforcement  of  obnoxious 
colonial  laws,  and  eventually  led  the  colonists  into  armed  resist- 
ance against  the  restrictive  legislation  of  the  English  govern- 
ment. 

English  Colonial  Policy  and  the  Navigation  Acts.  —  In 
accordance  with  mercantilist  views  of  colonial  relationships, 
English  statesmen  of  this  period  looked  upon  a  colony  as  a 
community  which  was  to  supply  raw  materials  for  the  industries 
of  the  mother  country,  secure  its  manufactured  goods  from  the 
mother  country,  and  so  far  as  trade  with  the  rest  of  the  world 
was  concerned,  buy  and  sell  through  the  mother  country.  In 
accordance  with  this  general  policy  England  gave  bounties 
for  the  production  in  America  of  raw  materials  such  as  flax, 
indigo,  naval  stores,  barrel  staves,  and  the  like,  but  restricted 
,  manufacturing  proper  —  by  prohibiting,  for  instance,  the  erec- 
tion of  mills  for  slitting  or  rolling  iron,  and  furnaces  for  making 
steel  —  and  fettered  our  commerce  in  a  variety  of  ways. 

The  English  laws  were  not  so  severe  as  might  be  inferred 
from  our  brief  statement  of  their  nature  and  purpose ;  they  were 
laxly  enforced ;  and  it  is  to  be  remembered  that  England 
encouraged  some  industries  while  she  attempted  to  destroy 
others.  English  colonial  policy  of  this  period  was  not  so  much 
malicious  as  mistaken.  The  important  points  for  us  are  these : 
that  it  did  not  seriously  hamper  the  development  of  American 
industry  in  general,  while  it  did  strengthen  and  stimulate  in  the 
American  people  that  spirit  of  individualism  which  the  industrial 
opportunities  of  the  New  World  and  the  frontier  conditions  of  the 
time  combined  to  create.     As  a  consequence  the  new  nation, 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED  STATES     8l 

created  in  1789,  was  pledged  to  the  doctrine  of  individual  liberty, 
and  its  constitution  contained  specific  guarantees  of  personal 
freedom  not  only  in  matters  political,  but  in  industrial  and 
social  relationships  as  well. 

American  Industries  in  1776. — When  the  Revolutionary 
War  broke  out,  American  industry  was  still  in  a  primitive  stage. 
The  extractive  industries  were,  relatively,  the  most  advanced. 
Large  quantities  of  lumber  and  timber  products  were  exported 
to  Europe ;  the  fisheries  were  in  a  prosperous  condition ;  and 
shipbuilding  had  reached  a  really  remarkable  stage  of  develop- 
ment, —  in  1775  "  nearly  one  third  of  the  tonnage  afloat  under 
the  British  flag  had  been  built  in  American  dockyards."  Agri- 
culture, however,  was  carried  on  in  the  most  wasteful  and  un- 
scientific way,  owing  to  the  cheapness  and  fertility  of  the  soil; 
and  manufacturing  was  still  in  the  household  stage.  In  the 
middle  and  New  England  Colonies  spinning  and  weaving,  the 
manufacture  of  shoes  and  food  products,  were  carried  on  within 
the  home ;  and,  in  fact,  the  typical  farm  household  of  this 
period  constituted  almost  an  independent  economic  unit,  rais- 
ing or  making  what  its  occupants  consumed,  and  buying  little 
save  salt  and  a  few  necessary  iron  implements.  Of  manufactur- 
ing for  sale  and  export,  however,  there  was  little  worth  men- 
tion. The  absence  of  adequate  means  of  transport  was  largely 
responsible  for  this  state  of  affairs.  The  roads  were  little 
more  than  widened  Indian  trails.  Some  years  later,  when  con- 
ditions were  considerably  improved,  the  roads  were  still  so  poor 
that  "  Madison  spent  a  week  going  from  New  York  to  Boston 
by  stage,  while  the  cost  of  cartage  of  a  cord  of  wood  for  a  dis- 
tance of  twelve  miles  was  three  dollars."  Agriculture,  however, 
was  the  dominant  industry  of  the  country.  In  1787  less  than 
one  eighth  of  the  working  population  was  engaged  in  manu- 
factures, fishing,  navigation,  and  trade  combined. 

The  Industrial  Revolution  in  America.  —  The  Industrial 
Revolution  was  sudden,  and  in  its  consequences  momentous 
in  America  as  well  as  in  England.  The  Revolutionary  War,  by 
interrupting  trade  with  Europe,  threw  the  American  people 
upon  their  own  resources:    goods  that  had  hitherto  been  im- 


82  OUTLINES  OF  ECONOMICS 

ported  had  now  to  be  manufactured  at  home ;  a  large  number  of 
new  industries  sprang  up  rapidly ;  and  the  idea  became  prev- 
alent that  the  new  nation  must  make  itself  industrially  as 
well  as  politically  independent  of  the  Old  World.  The  state 
governments  endeavored  to  foster  the  new  industries  by  protec- 
tive tariffs,  and  this  policy  was  later  continued,  in  a  moderate 
form,  by  the  federal  tariff  act  of  July  4,  1789.  Prizes  were 
offered  by  various  societies,  and  even  by  certain  state  govern- 
ments, for  the  introduction  of  the  new  machines  and  methods 
which  were  revolutionizing  industry  in  England.  Attracted 
by  one  of  these  offers,  Samuel  Slater,  "  the  father  of  American 
manufactures,"  who  had  been  apprenticed  to  a  manufacturer 
of  cotton  machinery,  and  was  particularly  familiar  with  Ark- 
wright's  machines  and  processes,  came  to  this  country  in  1789, 
and  in  the  following  year  started  the  first  cotton  factory  at  Paw- 
tucket,  Rhode  Island. 

The  factory  system  secured  its  first  real  foothold,  however, 
between  1806  and  1815,  when  the  Non-Intercourse  Acts,  the 
Embargo,  and  the  War  of  181 2,  by  suppressing  trade  with 
Europe,  forced  the  American  people  to  do  their  own  manu- 
facturing, and  turned  large  amounts  of  capital,  which  had  pre- 
viously been  employed  in  trade  and  shipping,  into  manu- 
factures. The  growth  during  this  period  of  isolation  was 
extraordinary.  In  1804  only  four  cotton  mills  were  in  opera- 
tion. "  In  1807  there  were  fifteen  cotton  mills  running  8000 
spindles  and  producing  300,000  pounds  of  cotton  yarn  annually. 
In  181 1  there  were  eighty-seven  mills  operating  80,000  spindles, 
producing  2,880,000  pounds  of  yarn  per  year  and  employing 
4000  men,  women,  and  children.  In  181 5,  500,000  spindles 
gave  employment  to  76,000  persons,  with  a  pay-roll  of  $15,000,- 
000  per  year."  l  When  resumption  of  peace  with  Great  Britain 
opened  the  new  American  industries  to  the  fierce  competition 
of  the  older  English  manufacturers,  many  failures  and  much 
suffering  ensued,  as  a  consequence  of  which  increased  protec- 
tion was  granted  in  the  tariff  acts  of  1816,  1824,  and  1828. 
A  little  later,  in  the  Middle  Atlantic  and  New  England  states, 

1  Coman,  Industrial  History  of  the  United  States,  p.  181. 


ECONOMIC   DEVELOPMENT  OF  THE   UNITED   STATES      83 

the  period  of  factory  production  had  fully  arrived.  A  separate 
class  of  wage  earners  was  appearing,  who  were  especially  ap- 
pealed to  by  new  arguments  concerning  wages  in  the  tariff 
discussions ;  workingmen's  parties  were  organized ;  strikes  and 
trades  unions  multiplied,  and  the  latter  were  combined  into 
municipal  and  state  federations ;  in  the  thirties  and  forties 
radical  reformers  linked  the  "  white  slaves  "  of  the  North  with 
the  negro  slaves  of  the  South  and  worked  for  the  abolition  of 
both  "  wage  and  chattel  slavery  " ;  the  factory  town  and  the 
city  slum  became  recognized  economic  conditions,  and  the 
dangers  of  the  latter  were  multiplied  by  the  heavy  immigration 
after  1845.  By  the  middle  of  the  nineteenth  century  the 
Industrial  Revolution  was  in  full  sway,  and  the  economic 
triumph  of  modern  capitalism  was  assured. 

As  might  be  supposed,  the  Industrial  Revolution  produced 
far  less  suffering  and  want  in  the  United  States  than  in  England. 
The  evils  attributable  to  the  Industrial  Revolution  in  England 
were  of  two  kinds.  One  arose  from  the  rapidity  and  magnitude 
of  the  industrial  change  itself;  the  other  was  due,  not  to  the 
change,  but  to  the  system  under  which  the  new  industry  was 
conducted  —  the  system  of  capitalistic  industry  working  in  a 
regime  of  practically  unregulated  competition.  In  our  country 
the  evils  resulting  from  transition  alone  were  slight.  Our 
manufacturing  industries  were  scarcely  started  when  the  spin- 
ning jenny,  the  power  loom,  and  the  steam  engine  were  intro- 
duced, and  so  almost  from  the  beginning  the  factory  system 
seemed  the  natural  one.  Thus,  the  change  which  in  England 
was  a  revolution  was  in  America  an  evolution,  a  process  of 
construction  with  little  destruction.  And  for  a  time  even 
those  evils  inherent  in  the  system  itself  were  mitigated  and 
disguised  by  the  immense  natural  wealth  of  this  country,  the 
ease  with  which  land  could  be  obtained,  and  the  unusual 
mobility  of  our  working  people  which  permitted  them  to  take 
quick  advantage  of  the  unusual  opportunities  open  to  them. 

But  these  ameliorating  agencies  served  only  to  check  and 
delay,  not  to  destroy,  the  evil  possibilities  of  the  new  industrial 
system.     As  free  land  has  become  less  and  less  abundant,  the 


84  OUTLINES  OF  ECONOMICS 

wage  earners  of  the  East  have  had  forced  upon  them  conditions 
of  life  which  have  kept  down,  although  they  have  not  absolutely 
lowered,  their  standard  of  life.  Extremes  of  wealth  and  aliena- 
tion of  social  classes  have  become  so  great  as  to  arouse  the  appre- 
hension of  all  thoughtful  men.  Labor  riots  that  call  for  mili- 
tary interference  testify  to  the  fact  that  we  have  not  escaped, 
that  in  the  future  we  can  hope  less  and  less  to  escape,  the  fric- 
tion that  accompanies  all  unf  raternal  relations  among  men.  We 
have  been  greatly  blest  in  that  we  have  escaped  the  worst  results 
so  long. 

The  Development  of  Agriculture.  —  The  presence  and  power 
of  those  economic  forces  which  softened  the  asperities  of  the  new 
industrial  system  in  America  are  revealed  in  a  particularly  strik- 
ing way  in  the  history  of  American  agriculture.  In  England,  it 
will  be  remembered,  the  changes  in  agriculture  intensified  the 
evils  of  the  Industrial  Revolution,  led  to  the  consolidation  of 
small  farms  into  large  landed  estates,  and  put  the  actual  busi- 
ness of  farming  largely  into  the  hands  of  tenants.  None  of 
these  things  happened  in  the  United  States.  The  great  area 
of  unoccupied  land  served  as  an  outlet  for  our  rapidly  growing 
population,  so  that  between  1850  and  1900  the  number,  acreage, 
and  output  of  our  farms  increased  more  rapidly  than  our  popu- 
lation. Farms  were  not  consolidated  but  broken  up ;  even 
today  nearly  two  thirds  of  our  farms  are  operated  by  their 
owners,  and  more  persons  are  employed  in  agriculture  than  in 
any  other  branch  of  industry.  There  is  a  constant  migration 
from  the  country  to  the  city,  to  be  sure,  but  this  is  in  no  sense 
due  to  the  consolidation  of  farms.  Thus  between  1880  and  19 10 
the  proportion  of  all  "  breadwinners  "  (persons  ten  years  of  age 
and  over  gainfully  occupied)  engaged  in  agriculture  fell  from 
44.4  to  32.9  per  cent.  But  great  improvement  in  agricultural 
methods  and  machinery  made  it  possible  for  the  relatively 
smaller  farm  population  to  satisfy  the  demand  for  agricultural 
produce  even  more  completely  at  the  end  than  in  the  middle 
of  the  nineteenth  century.  That  is  to  say,  the  machine  power 
introduced  into  farming  more  than  took  the  place  of  those 
persons  and  their  descendants  who  abandoned  agriculture.     It 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      85 

has  been  estimated,  for  instance,  that  in  1895  ft  actually  re- 
quired only  about  120,000,000  days'  work  to  produce  the  nine 
principal  farm  crops  of  that  year,  whereas,  had  they  been  pro- 
duced by  the  methods  and  machinery  of  1850,  at  least  570,000,- 
000  days'  work  would  have  been  required.1 

But  our  free  land  merely  served  to  postpone,  it  could  not  per- 
manently prevent,  the  appearance  in  America  of  some  of  the 
agricultural  conditions  which  accompanied  the  Industrial 
Revolution  in  England.  The  twentieth  century  ushered  in  a 
new  era  in  American  agricultural  development.  Between  1900 
and  1 9 10  the  number  and  acreage  of  farms  increased  far  less 
rapidly  than  the  population,  while  farm  tenancy  grew,  in 
close  relationship,  apparently,  with  an  extraordinary  increase 
in  farm  values.  "  The  increase  during  the  last  ten  years 
( 1 900-1910)  in  the  value  of  farm  property  was  equal  to  the 
total  increase  in  the  value  of  farm  property  in  the  United  States 
from  the  landing  of  Columbus  until  1900."  2  The  value  of 
farm  land  increased  118  per  cent  between  1900  and  1910; 
and  the  number  of  farms  operated  by  tenants  increased  16.3 
per  cent  as  against  an  increase  of  8.1  per  cent  in  the  number  of 
farms  operated  by  owners.  More  important  still,  the  average 
value  of  land,  buildings  and  equipment  per  farm  increased  from 
S3560  in  1900  to  $6440  in  1910.  These  figures  reflect  in  part 
a  simple  change  in  the  value  of  money ;  but  they  indicate  as 
well  the  increasing  importance  of  capitalistic  methods  of  pro- 
duction in  agriculture,  the  increasing  difficulty  of  acquiring 
farm  ownership,  and  the  sharp  halt  which  has  been  called  upon 
the  agricultural  expansion  which  marked  the  last  century. 
"  We  have  now  reached  a  stage  in  the  history  of  this  country 
when  farmers  in  average  years  do  not  produce  much  more  of 
the  raw  materials  used  for  food,  beverage,  and  clothing  than  is 
needed  within  the  country."  3 

lH.  W.  Quaintance,  "The  Influence  of  Farm  Machinery  on  Production  and 
Labor,"  Publications  of  the  American  Economic  Association,  Third  Series,  vol.  v, 
No.  4,  pp.  27-29. 

2  J.  L.  Coulter,  "Agriculture  in  the  United  States,"  Quarterly  Journal  of  Econom- 
ics, vol.  xxvii,  pp.  0-13. 

3  Coulter,  loc.  cit. 


86  OUTLINES  OF  ECONOMICS 

Manufactures.  —  In  agriculture,  however,  the  passage  of 
time  has  not  brought  about  a  highly  capitalized  form  of  indus- 
try, the  typical  farm  represents  only  a  relatively  small  invest- 
ment and  is  tilled  by  its  owner,  there  is  no  sharp  distinction 
between  employees,  unions  of  wage  earners  are  practically  un- 
known, and  passage  from  the  wage-earning  to  the  employing 
class  is  still  common.  In  manufactures,  practically  all  these 
conditions  have  been  reversed  since  the  end  of  the  eighteenth 
century.  And  it  is  the  tone  of  the  manufacturing  industry 
rather  than  that  of  agriculture  which  represents  the  keynote 
of  the  modern  economic  movement,  because  agriculture  is 
constantly  decreasing  while  manufacturing  and  allied  industries 
are  constantly  increasing  in  relative  importance.  At  the  be- 
ginning of  the  last  decade  of  the  eighteenth  century,  seven 
eighths  of  the  working  population  were  employed  in  agriculture, 
and  the  manufactured  products  of  the  country  were  valued  at 
$20,000,000.  Half  a  century  later,  in  1840,  77.5  per  cent  were 
employed  in  agriculture,  16.5  per  cent  in  trades  and  manu- 
factures alone,  and  the  products  of  the  manufacturing  industries 
were  valued  at  $483,000,000.  Fifty  years  later,  in  1890,  35.7 
per  cent  were  in  agriculture,  24.4  per  cent  in  manufacturing 
and  mechanical  pursuits,  and  the  manufactured  products 
were  valued  at  $9,370,000,000.  In  1909,  to  cite  the  latest 
figures,  32.9  per  cent  were  in  agriculture  and  28.3  per  cent  in 
manufacturing  and  mechanical  pursuits,  while  the  value  of  the 
products  had  reached  the  enormous  sum  of  $20,700,000,000. 

The  change  in  the  character  of  the  industry  has  been  even 
more  striking  than  its  growth  and  expansion.  In  the  first 
place,  machinery  and  capital  have  become  increasingly  promi- 
nent. In  1850,  for  instance,  $556  worth  of  capital  was  invested 
for  each  wage  earner,  while  in  1909  the  average  amount  of 
capital  per  wage  earner  was  $2785. l  In  the  second  place,  the 
organization  of  the  industry  has  changed,  so  that  the  individual 
owner  and  ordinary  partnership  are  rapidly  being  replaced  by 

1  Owing  to  variations  in  the  definition  of  "  capital "  and  other  similar  changes 
the  statistical  comparisons  made  in  this  and  the  preceding  paragraph  are  not  accu- 
rate, and  are  to  be  accepted  as  illustrations  rather  than  measurements. 


ECONOMIC   DEVELOPMENT  OF  THE   UNITED   STATES      87 

the  corporation.  At  the  beginning  of  the  nineteenth  century, 
corporations,  though  not  unknown  in  commerce  and  banking, 
were  very  uncommon  in  the  manufacturing  industries.  In 
1909,  incorporated  companies  employed  75.6  per  cent  of  the 
wage  earners  and  manufactured  79  per  cent  of  the  goods  pro- 
duced in  all  the  manufacturing  industries. 

This  change  in  organization  has  been  a  powerful  factor  in  de- 
stroying the  personal  relation  between  the  owners  of  capital 
and  the  wage  earners  who  man  their  plants,  and  has  thus 
helped  to  widen  the  growing  breach  between  capital  and  labor. 
It  has  also  contributed  greatly  to  the  concentration  of  industrial 
control.  Law  and  custom  in  this  country  have  combined  to 
make  the  small  stockholder  in  the  largest  corporations  a  virtual 
nonentity  so  far  as  practical  participation  in  the  management 
of  the  corporation  is  concerned ;  and  the  individual  or  clique 
of  "  insiders  "  who  own  a  bare  majority  of  the  stock  too  fre- 
quently rule  the  business  despotically.  Incorporation,  then, 
instead  of  introducing  a  greater  measure  of  real  industrial  co- 
operation and  thus  democratizing  industry,  has  too  often  turned 
out  to  be  an  ingenious  device  by  which  energetic  promoters 
borrow  or  secure  the  spare  savings  of  the  community  on  the 
most  flexible  terms  and  with  a  minimum  of  responsibility.  The 
corporation  thus,  while  it  appeared  to  be  diffusing  the  ownership 
of  industry,  has  in  reality  worked  toward  the  concentration  of 
industrial  control. 

Other  forces,  moreover,  have  been  working  toward  industrial 
concentration,  the  most  powerful  of  which,  perhaps,  has  been 
competition  itself.  For  many  decades  in  this  country  the 
competition  among  rival  manufacturers  was  bitter  and 
practically  unrestricted.  Tied  down  to  their  large  investments 
of  fixed  capital,  they  were  compelled  to  stand  and  fight  with- 
out quarter.  In  every  such  war  the  number  of  combatants 
tends  to  decrease.  As  old  rivals  are  killed  off,  the  successful 
acquire  greater  skill  and  greater  power  in  the  conflict.  With 
the  passage  of  time  greater  and  greater  equipment  is  required  to 
give  any  hope  of  a  successful  struggle,  and  some  of  the  contest- 
ants, learning  prudence  from  the  struggle,  combine  to  increase 


88  OUTLINES  OF  ECONOMICS 

their  fighting  power.  The  inevitable  result,  whether  through 
simple  survival  of  the  fittest  or  through  combination,  is  a  marked 
increase  in  the  size  and  importance  of  the  industrial  unit.  Be- 
tween 1899  and  1909,  for  instance,  the  number  of  establishments 
in  the  factory  industries  increased  only  29.4  per  cent,  but  their 
capital  increased  105.3  Per  cent,  and  the  value  of  their  products 
81.2  per  cent.  In  many  of  our  most  important  industries  the 
number  of  establishments  is  actually  decreasing.  In  the  manu- 
facture of  agricultural  implements  between  1880  and  1909,  to 
take  a  single  illustratipn  of  the  many  that  might  be  cited,  the 
number  of  establishments  decreased  from  1943  to  640,  while 
the  wage  earners  increased  from  39,580  to  50,551,  and  the  value 
of  the  products  from  $68,640,000  to  $146,330,000. 

There  are  industries,  of  course,  in  which  no  such  consolida^ 
tion  has  taken  place,  but  they  are  unimportant  in  comparison 
with  those  in  which  it  has.  The  extent  to  which  the  giant  in- 
dustry and  large-scale  production  had  come  to  dominate  our 
manufacturing  industries  in  the  year  1909  is  shown  in  the  follow- 
ing table,  which  will  repay  careful  study.  Establishments  of 
the  largest  size,  i.e.  those  whose  annual  output  exceeded  $1,000,- 
000,  constituted  a  little  over  1  per  cent  of  the  number  of  estab- 
lishments, but  manufactured  nearly  44  per  cent  of  all  the  goods. 
Nearly  three  fourths  of  the  wage  earners  were  employed  in 
establishments  having  a  capital  of  more  than  $100,000  each. 

In  the  latter  part  of  the  nineteenth  century  the  movement 
toward  large-scale  industry  took  on  another  phase.  In  addition 
to  concentration  or  centralization  of  industry,  we  are  now  having 
a  rapidly  increasing  integration  of  industry.  Large  business 
concerns  are  finding  it  profitable  to  carry  on  under  one  manage- 
ment several  closely  related  industries.  For  illustration,  take 
the  case  of  the  United  States  Steel  Corporation.  Here  we  have 
united  under  one  management  the  American  Bridge  Company, 
the  American  Sheet  Steel  Company,  the  American  Steel  Hoop 
Company,  the  American  Steel  and  Wire  Company,  the  American 
Tin  Plate  Company,  the  Federal  Steel  Company,  the  Lake 
Superior  Consolidated  Iron  Mines,  the  National  Steel  Company, 
the  National  Tube  Company,  and  the  Carnegie  Steel  Company. 


ECONOMIC  DEVELOPMENT  OF  THE  UNITED   STATES     89 


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90  OUTLINES  OF  ECONOMICS 

Of  the  last  itself,  Mr.  Charles  M.  Schwab  said  in  his  testimony, 
before  the  Industrial  Commission:  *  "  The  Carnegie  Company 
were  large  miners  of  ore  —  mined  all  the  ore  that  they  re- 
quired themselves,  to  the  extent  of  over  4,000,000  tons  per 
year.  They  transported  a  large  percentage  of  it  in  their 
own  boats  over  the  lakes ;  they  carried  a  large  percentage  of 
it  over  their  own  railroad  to  their  Pittsburgh  works,  and 
manufactured  it  there,  by  the  various  processes,  into  a  great 
variety  of  iron  and  steel  articles  —  I  think  perhaps  a  larger 
general  variety  of  steel  articles  than  almost  any  other  manu- 
facturing concern." 

Transportation  and  Railways.  —  The  industrial  concentration 
of  which  we  have  been  speaking  does  not  necessarily  lessen 
competition  at  all.  It  merely  gives  the  business  into  the  hands 
of  increasingly  powerful  rivals  among  whom  competition  may 
be  all  the  more  bitter  because  of  the  size  of  the  contestants.  But 
in  the  principal  transportation  industries  time  has  demonstrated 
that  another  rule  prevails:  competition  has  failed  to  protect 
the  consumer,  and  the  progress  of  consolidation  has  operated 
to  emphasize  the  monopolistic  character  of  the  industry. 

The  history  of  transportation  in  this  country  since  the  estab- 
lishment of  the  Union  falls  into  three  stages.  The  "  turnpike 
period  "  extends  from  1790,  the  year  in  which  the  first  turnpike 
was  constructed,  until  1816,  when  steam  navigation  upon  the 
Ohio  River  became  fairly  regular.  The  second  stage,  the  "  river 
and  canal  period,"  ends  after  the  panic  of  1837,  and  is  marked 
particularly  by  the  introduction  of  steam  travel  on  the  Hudson 
(1807),  the  Ohio,  and  Mississippi  rivers  (1808  to  181 7),  and  the 
opening  of  the  Erie  Canal  in  1825.  The  last  stage,  the  "  period 
of  the  railway,"  extends  from  about  1842  to  the  present  time. 
In  contrasting  these  periods,  it  is  not  meant  to  suggest  that 
canals  were  not  built  before  1790,  or  that  turnpikes  are  not  im- 
portant at  the  present  time.  As  a  matter  of  fact,  a  canal  was 
built  in  Orange  County,  New  York,  as  early  as  1750;  and  the 
last  few  years  have  witnessed  a  rapid  and  costly  improvement 
of  our  highways.    These  "  periods  "  merely  indicate  the  kind 

1  Report  of  the  Industrial  Commission,  vol.  xiii,  p.  448. 


ECONOMIC   DEVELOPMENT  OF  THE   UNITED   STATES      9 1 

of  transportation  facilities  which  at  different  times  have  been 
most  prominent  in  the  minds  of  the  people. 

In  the  development  of  the  railway,  certain  approximately 
definite  stages  may  also  be  distinguished.  Between  1830  (when 
the  first  important  railway  —  the  Baltimore  and  Ohio  —  was 
opened)  and  1840,  the  railways  were  short  local  lines  used  in 
large  degree  to  supplement  or  piece  out  the  rivers  and  canals. 
In  the  next  period,  1840  to  1870,  many  new  roads  were  built, 
and  the  process  of  "  linear  consolidation  "  —  the  linking  to- 
gether of  local  companies  into  through  trunk  lines  —  began. 
By  1869  both  the  New  York  Central  and  the  Pennsylvania 
had  effected  through  connections  with  Chicago.  In  the  same 
year,  the  completion  of  the  Central  and  Union  Pacific  railways 
linked  the  Pacific  Ocean  with  the  eastern  railways,  and  the 
continent  was  spanned. 

The  period  between  1870  and  1890  is  marked  by  three  striking 
developments.  First,  it  was  a  period  of  feverish  expansion : 
the  railway  mileage  of  the  country  increased  from  52,000  to 
160,000  miles,  more  than  200  per  cent.  Secondly,  the  com- 
pletion of  several  through  routes  from  the  Atlantic  seaboard 
to  Chicago  brought  about  a  period  of  destructive  competition, 
which  led  to  discrimination  and  rebating  in  through  traffic  and 
the  overcharging  of  local  or  non-competitive  traffic.  "  Wher- 
ever competition  appeared,  discrimination  followed;  and  in 
the  scramble  for  business  the  stronger  shippers  were  favored 
at  the  expense  of  the  weaker.  Where  there  was  no  competition 
the  public  felt  that  they  were  being  oppressed  by  a  monopoly,  to 
make  up  for  sacrifice  rates  elsewhere  —  a  feeling  which  was  in- 
tensified by  the  absentee  ownership  of  the  western  roads." l 
Thirdly,  this  condition  of  demoralization  led  to  a  double  re- 
action. The  railways  sought  to  restrain  competition  by  the 
creation  of  pools  and  traffic  agreements,  while  the  people  sought 
to  protect  themselves  through  legislation  and  the  creation  of 
railway  commissions.  The  Federal  or  Interstate  Commerce 
Commission  was  established  in  1887. 

The  last  period,  from  1890  to  the  present  time,  has  been 

1 H.  C.  Emery  in  The  Cambridge  Modern  History,  vol.  vii,  p.  706. 


<)2  OUTLINES  OF  ECONOMICS 

marked  by  an  unprecedented  amount  of  combination  among 
competing  roads,  and  by  a  growing  belief  that  the  railway  indus- 
try is  inherently  monopolistic  and  must  be  subjected  to  public 
control.  Thus,  at  the  same  time  that  the  control  of  the  magnifi- 
cent railway  system  of  this  country  —  greater  in  extent  than 
all  the  railways  of  Europe  combined  —  has  fallen  into  the  hands 
of  a  comparatively  small  number  of  groups,  the  people  them- 
selves have  perfected  administrative  machinery  strong  enough, 
it  is  hoped,  to  hold  the  monopoly  in  check.  Very  recently 
strong  efforts  have  been  made  to  preserve  competition  in  the 
railway  industry,  but  it  is  coming  to  be  seen  that  in  the  main 
reliance  will  have  to  be  placed  upon  regulation  rather  than 
competition.  The  amendment  of  the  Interstate  Commerce  Act 
in  1906  is  a  public  recognition  of  the  fact  that  the  old  problem 
of  private  competition  versus  public  regulation  has  given  way 
to  the  new  problem  of  public  regulation  versus  public  ownership ; 
and  public  operation  may  be  given  a  trial  in  the  near  future 
on  the  thousand  miles  of  railroad  which  Congress  (in  March, 
1914)  authorized  the  President  to  construct  in  Alaska. 

It  would  be  almost  impossible  to  exaggerate  the  part  which  transportation 
agencies,  and  particularly  the  railways,  have  played  in  the  economic  develop- 
ment of  this  country.  Ours  is  a  country  of  "magnificent  distances,"  and 
because  of  this  fact,  it  was  particularly  necessary  that  superior  means  of 
communication  and  transportation  should  be  early  introduced,  if  the  country 
was  to  be  held  together.  After  the  Revolutionary  War  there  was  real  danger 
that  the  settlers  west  of  the  Alleghanies  would  be  completely  alienated. 
Washington  was  quick  to  realize  this  fact.  "The  Western  settlers,"  he  wrote 
to  the  governor  of  Virginia,  shortly  after  the  Revolutionary  War,  "stand  as  it 
were  upon  a  pivot.  The  touch  of  a  feather  would  turn  them  any  way.  They 
have  looked  down  the  Mississippi  until  the  Spaniards,  very  impoliticly,  I 
think,  for  themselves,  threw  difficulties  in  their  way;  and  they  looked  that 
way  for  no  other  reason  than  because  they  could  glide  gently  down  the 
stream,  without  considering,  perhaps,  the  difficulties  of  the  voyage  back 
again,  and  the  time  necessary  to  perform  it  in;  and  because  they  have  no 
other  means  of  coming  to  us  but  by  long  land  transportations  and  unim- 
proved roads." 

This  danger  was  averted  by  the  building  of  the  Cumberland  Road,  the 
introduction  of  steam  navigation  on  the  Ohio,  and  the  completion  of  the  Erie 
Canal.  Later  it  looked  as  if  the  use  of  the  Mississippi  and  other  natural 
avenues  of  communication  would  link  the  Middle  West  more  closely  to  the 


ECONOMIC   DEVELOPMENT  OF  THE   UNITED   STATES      9^ 

South  than  the  northeastern  states,  thus  giving  the  South  a  preponderant 
influence  in  the  inevitable  struggle  over  slavery.  This  problem,  however, 
was  solved  by  the  railways,  which,  unlike  the  rivers,  ran  east  and  west  rather 
than  north  and  south.  The  railway  was  thus  a  strong  factor  in  the  preser- 
vation of  the  Union.  And  since  the  Civil  War,  western  settlement  has  fol- 
lowed the  railway.  It  has  been  the  great  pioneering  agency  of  the  last  half 
century,  and  is  entitled  to  as  much  credit  as  the  public  land  policy  for  the 
rapid  settlement  of  the  West. 

In  the  development  of  our  transportation  facilities,  however,  the  State  has 
been  from  the  very  first  an  active  partner  of  private  enterprise.  Not  only 
has  the  State  built  roads,  canals,  and  railways  of  its  own,  but  it  subsidized 
the  private  companies  which  engaged  in  similar  enterprises,  with  prodigal 
liberality.  Of  the  total  state  debts  —  $170,800,000  in  all  —  contracted 
prior  to  1838,  $60,200,000  were  chargeable  to  canals,  $42,870,000  to  railways, 
$52,600,000  to  banks,  $6,600,000  to  roads,  and  $8,500,000  to  miscella- 
neous objects.  After  the  panic  of  1837  there  was  little  direct  construction 
by  the  State  of  internal  improvements,  but  national,  state,  and  local  govern- 
ments vied  with  one  another  in  assisting  private  companies  by  exemptions 
from  taxation  and  by  grants  of  land,  money,  and  credit.  How  much  these 
subsidies  amounted  to  we  do  not  know,  but  the  aggregate  must  have  been 
enormous,  as  appears  from  the  statistics  of  land  grants.  "During  the 
twenty-one  years  between  1850  and  187 1,  at  which  time  land  grants  were 
discontinued,  more  than  159,000,000  acres  were  placed  at  the  disposal  of 
railroad  corporations  by  the  federal  government  and  55,000,000  by  the 
state  governments."  '  In  their  origin  and  genesis,  therefore,  as  well  as  in 
their  essential  nature,  the  railways  are  quasi-public  institutions. 

The  Labor  Movement.  —  In  the  preceding  pages  we  have 
seen  how  capitalistic  industry  under  a  regime  of  free  competition 
passed  from  an  earlier  period  of  cut-throat  rivalry  to  a  later 
period  of  combination  amounting  in  many  cases  to  monopoly. 
A  similar  phenomenon  is  discernible  in  the  labor  movement. 
At  the  beginning  of  the  nineteenth  century  there  were  probably 
less  than  a  dozen  trade  unions  in  the  United  States,  and  we 
actually  know  of  the  existence  of  only  one.  Between  1825  and 
the  panic  of  1837,  however,  they  multiplied  rapidly,  and  efforts 
were  made  to  unite  the  scattered  "  locals  "  of  separate  trades 
into  broader  national  unions,  and  to  confederate  the  unions  of 
different  trades  into  municipal  and  district  federations.  These 
efforts  were  only  partially  successful,  however,  and  it  was  not 

1  Bogart,  Economic  History  of  the  United  Slaks,  pp.  195,  308,  passim. 


94  OUTLINES  OF  ECONOMICS 

until  after  1850  that  permanent  national  unions  were  established, 
and  not  till  the  organization  of  the  Knights  of  Labor  in  1869 
that  a  fairly  permanent  national  federation  was  created.  The 
Knights  of  Labor  reached  the  zenith  of  its  power  about  1886, 
and  since  the  panic  of  1893  its  place  has  been  gradually  taken 
by  the  American  Federation  of  Labor,  with  which  most  Ameri- 
can unions,  except  those  of  the  bricklayers  and  masons,  the 
Railway  Brotherhoods,  and  the  Industrial  Workers  of  the 
World,  are  affiliated.  In  1893  the  membership  of  the  American 
Federation  of  Labor  numbered  about  250,000.  By  19 14  it 
had  grown  to  2,020,671.  These  figures  give  some  idea  of 
the  strikingly  rapid  growth  of  trade  unionism  in  the  last  twenty 
years.  As  the  membership  of  the  American  Federation  of 
Labor  is  usually  understated,  and  as  there  are  probably  about 
750,000  members  in  organizations  not  affiliated  with  the  Ameri- 
can Federation,  we  conclude  that  the  aggregate  membership 
of  American  labor  organizations  at  the  close  of  the  year  19 14 
amounted  to  about  2,750,000  persons,  mostly  men.1 

There  are  at  least  five  periods  distinguishable  in  the  history 
of  American  trade  unionism:  the  germinal  period,  1789-182 5: 
the  revolutionary  period,  1825-1850,  so  called  because  of  the 
close  connection  in  this  period  between  trade  unionism  and 
more  radical  reforms  such  as  socialism  and  cooperation;  the 
period  of  nationalization,  1 850-1 865;  the  period  of  federation 
1865-1897;  and  the  period  of  collective  bargaining,  1898  to  the 
present  time.  We  speak  of  the  present  epoch  as  the  period 
of  collective  bargaining  because  of  the  rapid  expansion  of  union- 
ism, and  the  establishment  of  many  new  national  or  district 
systems  of  collective  bargaining  after  the  industrial  depression 
of  1 893-1 897 ;  and  because  it  is  only  in  recent  years  that  em- 
ployers and  the  general  public  have  recognized  that  the  trade 
union  is  here  to  stay,  and  must  be  regarded  as  a  permanent 
institution  with  which  many  employers  of  labor  must  bargain, 
whether  they  like  it  or  not. 

1  Dr.  Leo  Wolman,  in  a  recent  careful  study  (Quarterly  Journal  of  Economics, 
vol.  xxx,  p.  496),  estimates  the  total  trade  union  membership  in  the  United  State* 
and  Canada  in  ioio  as  2,22,?  000. 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      95 

The  avowed  aim  of  the  trade  unions  is  a  complete  combination 
of  all  the  workers  in  a  given  occupation  or  industry.  The  Broth- 
erhood of  Locomotive  Engineers,  for  instance,  probably  counts 
among  its  members  more  than  90  per  cent  of  all  the  locomotive 
engineers  in  North  America,  although  there  are  few  trades 
which  are  so  completely  organized  as  this.  With  the  passage  of 
time,  moreover,  the  trade  unions  have  made  increasing  use  of 
the  monopolistic  principle  of  the  closed  shop  —  the  principle 
which  leads  union  men  to  refuse  to  work  with  nonunion  men, 
and  which  finds  expression  in  the  trade  unionist's  new  command- 
ment:   "Thou  shalt  not  take  thy  neighbor's  job." 

The  development  of  powerful  combinations  in  the  labor  world 
has  engendered  a  counter  movement  among  the  employers,  which 
expresses  itself  concretely  in  the  modern  employers'  association. 
Such  organizations  are  not  new;  we  have  record  of  such  an 
association  among  the  master  shoemakers  of  Philadelphia  in 
1789.  But  in  recent  years  these  associations  have  become  per- 
manent, formal,  and  aggressive.  They  fight  the  labor  organiza- 
tions with  their  own  weapons,  matching  the  lockout  against  the 
strike,  the  black  list  against  the  boycott,  and  the  "  labor 
bureau  "  against  the  "  unfair  list  "  with  which  the  reader  of 
trade-union  journals  is  familiar.  Most  of  the  employers' 
associations,  like  most  of  the  trade  unions,  have  associated 
themselves  for  common  action  in  a  large  national  federation, 
the  Citizens'  Industrial  Association  of  America,  with  which, 
in  December,  1903,  there  were  affiliated  sixty  national  em- 
ployers' associations,  sixty-six  State  and  district  associations, 
and  three  hundred  and  thirty-five  local  or  municipal  associations 
of  employers. 

This  fight  between  organized  labor  and  organized  capital 
return  has  forced  the  State,  in  the  interest  of  industrial  peace, 
to  inaugurate  "  Wage  Boards  "  and  Boards  of  Arbitration  and 
Conciliation.  Some  of  these,  such  as  the  New  Zealand  Court  of 
Arbitration,  are  empowered  to  enforce  their  awards  upon  em- 
ployers and  employees;  while  others,  like  the  Canadian  and 
some  of  the  American  State  Boards  of  Arbitration,  have  no 
Dower  to  settle  disputes  authoritatively,  although  they  ma> 


96  OUTLINES  OF  ECONOMICS 

make  "  compulsory  investigations  "  and  publish  their  finding 
as  to  the  equities  of  the  case.  These  and  similar  topics,  how- 
ever, are  reserved  for  more  detailed  discussion  in  a  later  chapter. 
State  Regulation  of  Industry.  —  The  growing  interference  of 
the  State  in  the  conflict  between  capital  and  labor  brings  us 
naturally  to  the  general  subject  of  the  State  in  relation  to  indus- 
try. When  the  American  colonies  were  planted,  mercantilism 
was  the  dominant  political  philosophy;  but,  as  we  have  seen, 
mercantilism  gave  way  to  a  philosophy  of  individualism  in  the 
eighteenth  century,  under  the  combined  influence  of  the  reaction 
against  the  English  Navigation  Acts,  the  natural  antipathy 
of  a  frontier  community  to  legal  restraint,  the  philosophy  of 
Locke,  and  in  a  minor  degree  the  teachings  of  the  French  physi- 
ocrats. The  triumph  of  individualism,  as  a  philosophical 
system,  came  at  the  critical  period  when  our  State  and  federal 
constitutions  were  in  the  making,  and  it  thus  became  intrenched 
in  the  organic  law  of  the  nation,  giving  constitutional  sanction 
to  the  doctrine  of  laissez-faire,  and  establishing  a  constitutional 
guarantee  of  freedom  of  contract,  in  accordance  with  which  adult 
men  were  left  "  free  "  to  work  as  long  as  they  "  pleased  "  (or  were 
compelled),  for  whatever  wages  they  were  "  pleased  "  (or  forced) 
to  accept.  Under  the  influence  of  these  doctrines,  for  instance, 
our  courts  have  annulled  such  wholesome  regulations  as  laws 
prohibiting  payment  of  wages  in  store  orders,  and  statutes 
limiting  the  hours  of  labor  of  men  in  bakeshops,  or  other  ex- 
hausting occupations.  Decades  of  experience  have  amply 
proved  that  the  average  wage  earner  is  too  weak  to  protect 
himself  against  many  evils;  but  our  constitutional  law  has 
made  it  exceedingly  difficult  for  the  State  to  protect  him.  For- 
tunately, however,  the  American  people  have  a  fashion  of 
bending  their  constitutional  law  to  fit  the  facts,  not  blinding 
themselves  to  the  facts  by  worshiping  the  law;  and  in  recent 
years  the  Supreme  Court  of  the  United  States  has  sanctioned 
laws  requiring  the  semi-monthly  payment  of  wages,  prohibiting 
the  payment  of  wages  in  goods,  and  requiring  the  wages  of  certain 
miners  to  be  based  upon  the  weight  of  the  coal  before  screening. 
Many  of  the  State  courts,  however,  are  far  less  enlightened. 


ECONOMIC  DEVELOPMENT  OF  THE  UNITED  STATES   97 

It  is  impossible  to  show  in  detail  how  the  free  trade  and  indi- 
vidualistic tendencies  of  the  Revolutionary  period  gave  way  to 
a  constantly  growing  program  of  State  interference.  The 
doctrine  of  laissez-faire  was  never  adopted  in  its  entirety,  and 
year  by  year  we  have  moved  farther  and  farther  away  from  it. 
State  interference  began  with  the  adoption  of  a  tariff  act  in 
1789,  "  for  the  support  of  the  government,  for  the  discharge  of 
the  debts  of  the  United  States,  and  the  encouragement  and 
protection  of  manufactures  " ;  reached  almost  a  maximum  in 
the  Embargo  Act  of  1807  ;  showed  itself  in  the  policy  of  internal 
improvements  and  State  aid  to  turnpike,  canal,  and  railway 
companies;  brought  us  the  great  mass  of  labor  and  factory 
legislation  which  has  been  adopted  by  so  many  states  since  the 
Civil  War ;  led  in  turn  to  the  Interstate  Commerce  Act  of  1887, 
the  Sherman  Anti-trust  Act  of  1890,  the  National  Meat  In- 
spection and  Pure  Food  Laws;  and  finally  culminated  in  the 
Clayton  Anti-trust  and  the  Federal  Trade  Commission  Acts  of 
19 1 4.  Excessive  competition  among  laborers,  which  forced 
them  to  accept  work  under  conditions  destructive  of  physique 
and  morals,  has  led  to  the  factory  acts,  prohibition  of  child 
labor,  and  limitation  of  the  hours  of  labor  of  women ;  excessive 
competition  leading  to  the  adulteration  of  products  and  their 
manufacture  under  insanitary  conditions  has  given  us  the  meat 
inspection  and  pure  food  laws;  excessive  competition  among 
corporations,  leading  to  combination  and  oppressive  monopoly, 
has  brought  us  the  anti-trust  acts  and  regulation  through  State 
and  national  commissions.  The  rapid  adoption  of  workmen's 
compensation  and  minimum  wage  laws  by  the  State  govern- 
ments in  recent  years,  is  striking  evidence  that  we  have  entered 
a  new  era,  in  which  State  interference  and  control  is  not  unlikely 
to  become  excessive.  Whether  the  individualistic  character 
of  industrial  society  endures  or  disappears,  individualists  and 
socialists  alike  are  now  agreed  that  the  State  must  interfere. 
As  a  prominent  English  statesman  expressed  it,  "  We  are  all 
jocialists  now,"  although  he  merely  meant  by  this  statement 
that  the  passive  theory  of  government  has  been  wholly  dis- 
credited. 


98  OUTLINES  OF  ECONOMICS 

Up  to  the  present  time  State  interference  has  had  as  its  princi- 
pal object  the  improvement  and  preservation  of  competition. 
The  conscientious  manufacturer  who  would  not  poison  con- 
sumers for  the  sake  of  swelling  his  profits,  the  high-minded 
employer  who  would  not  "  sweat  "  women  and  children  merely 
to  reduce  the  cost  of  production,  the  delicately  scrupulous 
shipper  who  would  not  undermine  a  rival  by  forcing  a  common 
carrier  to  pay  him  rebates,  —  all  these  have  suffered  as  much 
from  the  abuses  of  competition  as  the  general  public  itself. 
Industry  under  the  competitive  regime  is  a  rough  game  played 
for  high  stakes,  and  if  it  is  to  be  played  fairly,  there  must  be 
intelligent  rules  of  the  game  and  an  umpire  powerful  enough 
to  enforce  them  upon  all  contestants  alike.  If  the  manufacturers 
of  Massachusetts  are  prohibited  from  employing  children  under 
fourteen  years  of  age  while  those  of  South  Carolina  are  en- 
couraged to  do  so,  decency  is  penalized,  and  the  victory  goes  to 
the  contestant  guilty  of  the  greatest  number  of  fouls. 

State  interference,  as  we  have  said,  has  had  as  its  principal 
object  the  maintenance  of  competition  upon  a  higher  and  more 
wholesome  basis.  But  this  has  not  been  its  sole  object.  Our  re- 
cent regulation  of  public  utility  companies  aims  not  to  bolster  up 
or  preserve  competition  among  such  companies,  but  to  introduce 
a  substitute  for  competition;  and  it  is  possible  that  in  certain 
lines  of  industry  regulated  monopoly  may  prove  on  the  whole 
more  beneficial  than  regulated  competition.  Whether  it  is 
desirable,  whether  in  the  long  run  it  will  be  possible,  to  main- 
tain a  competitive  as  distinguished  from  a  socialistic  regime 
of  industrial  society,  may  be  said  to  be  the  supreme  economic 
problem  of  the  twentieth  century. 

QUESTIONS 

i.  How  do  you  account  for  the  failure  of  the  early  colonial  restrict"*e 
legislation  ? 

2.  What  was  the  effect  of  English  colonial  policy  and  the  Navigation 
Acts  upon  American  manufactures?  shipbuilding?  American  political 
philosophy  ? 

3.  What  was  the  condition  of  American  agriculture  in  1776?  of  .manu- 
factures?   shipbuilding?    transportation? 


ECONOMIC   DEVELOPMENT  OF  THE  UNITED   STATES      99 

4.  Was  the  Industrial  Revolution  as  important  in  this  country  as  in 
England?    Was  it  attended  with  as  much  suffering?    Why? 

5.  What  part  has  been  played  by  war  in  the  tariff  and  industrial  history 
of  the  United  States? 

6.  In  what  respects  has  the  agricultural  development  of  this  country 
differed  from  that  of  England?   from  that  of  the  manufacturing  industry? 

7.  What  changes  have  taken  place  in  the  organization  of  manufacturing 
industries  in  the  last  century? 

8.  What  are  the  principal  causes  and  effects  of  industrial  concentration? 

9.  What  is  the  difference  between  industrial  concentration  and  integra- 
tion?  between  large-scale  production  and  monopoly? 

10.  What  stages  are  distinguishable  in  the  history  of  transportation  and 
railways  in  this  country? 

11.  What  part  did  the  State  play  in  the  development  of  railways?  Is 
railway  consolidation  a  recent  phenomenon? 

12.  What  movement  has  the  development  of  trade  unionism  elicited 
from  employers  ?  from  the  State  ? 

13.  How  did  the  doctrine  of  non-interference  secure  such  a  strong  foot- 
hold in  American  constitutional  law?  What  has  been  the  principal  object 
of  State  interference  up  to  the  present  time? 

REFERENCES 

(See  also  References  for  Chapter  V) 

Beard,  C.  A.     Contemporary  American  History. 

Beer,  G.  L.     The  Old  Colonial  System,  1660-1754. 

Bishop,  J.  L.     History  of  American  Manufactures. 

Bryn,  E.  W.     Progress  of  Invention  in  the  Nineteenth  Century. 

Census  Reports.  Tenth  Census,  Agriculture,  p.  131;  Twelfth  Census, 
■     Manufactures,  Part  i,  Chap,  ii,  i-iv,  xvii,  xxxix. 

Cleveland,  F.  A.,  and  Powell,  F.  W.  Railroad  Promotion  and  Capitaliza- 
tion in  the  United  States. 

Commons,  J.  R.  (ed.)  Documentary  History  of  American  Industrial  Society. 
(10  volumes.) 

Dewey,  D.  R.    Financial  History  of  the  United  States. 

Giesecke,  A.  A.     American  Commercial  Legislation  before  Ij8g. 

Hadley,  A.  T.     Railroad  Transportation,  its  History  and  its  Laws. 

Johnson,  E.  R.     American  Railway  Transportation. 

Rabbeno,  Ujo.     The  American  Commercial  Policy. 

Taussig,  F.  W.     Tariff  History  of  the  United  States. 

Weber,  A.  F.  "The  Growth  of  Cities  in  the  Nineteenth  Century,"  Co- 
lumbia University  Studies  in  History,  Economics,  and  Public  Law. 
Vol.  ii. 

Wells,  D.  A.    Recent  Economic  Changes. 

Wickware,  F.  G.  (ed.).     The  American  v"ir  Book. 


BOOK    II 
PRINCIPLES    AND    PROBLEMS 


PART  I 

PRODUCTION  AND  CONSUMPTION 

CHAPTER  VII 
ELEMENTARY   CONCEPTS 

In  political  economy  many  of  the  technical  terms  employed 
are  often  misunderstood  because  the  same  words  are  used  in 
ordinary  speech  with  inconsistency  and  confusion.  Frequently 
we  have  to  choose  between  the  alternatives  of  being  inconsistent 
and  of  violating  current  usage.  The  present  chapter  is  devoted 
to  a  preliminary  survey  of  some  of  the  fundamental  notions  in 
political  economy. 

The  statement  is  sometimes  made  that  economics  is  a  mere 
bread-and-butter  science,  and  this  charge  is  not  without  some 
foundation,  since  the  science  studies  men  in  their  endeavor  to 
make  a  living,  but  it  would  be  an  error  to  suppose  that  we  are 
concerned  with  only  the  sordid  aspects  of  human  nature.  This 
is  apparent  if  we  enumerate  the  motives  which  impel  men  to 
acquire  wealth. 

Motives  in  Economic  Activity.  —  (i)  There  is,  in  the  first 
place,  the  endeavor  to  satisfy  one's  strictly  personal  wants, 
giving  rise  to  the  struggle  for  food,  shelter,  comforts,  amuse- 
ment, etc.  These  things  are  wanted  for  their  own  sake,  because 
of  the  effect  which  they  produce  upon  the  individual  acquiring 
them.  We  have  here,  in  short,  the  motive  of  self-maintenance 
and  self -development.  (2)  But  every  normal  individual  feels 
such  a  degree  of  affection  for  certain  other  people  that  he  is 
also  anxious  for  their  maintenance  and  development.  Striving 
for  the  welfare  of  others  is  a  second  motive  which  impels  men  to 
labor  for  the  acquisition  of  material  things,  and  in  many  cases 
is  more  effective  as  a  spur  to  endeavor  than  the  first.    A  man 

103 


104  OUTLINES  OF  ECONOMICS 

will  hold  himself  to  the  daily  grind  more  persistently  when  he 
feels  some  one  is  dependent  upon  him  than  when  he  is  standing 
alone. 

Another  motive  is  (3)  the  desire  to  gain  the  esteem  of  one's 
fellows.  This  motive  may  take  the  form  of  an  endeavor  to  do 
one's  part  and  to  be  deserving  of  the  companionship  of  the 
class  of  people  whom  we  admire.  But  much  of  our  wealth 
acquisition  is  motivated  by  the  hope  of  impressing  our  fellows 
with  a  sense  of  our  own  importance,  to  show  that  we  are  success- 
ful, admirable,  enviable.  When  the  income  permits,  old  coats 
are  discarded,  not  because  they  cease  to  give  protection,  nor 
because  they  have  become  aesthetically  objectionable,  but 
because  the  wearers  wish  to  make  a  favorable  impression  upon 
other  people.  Part  of  the  pleasure  of  owning  fine  houses  may 
come  from  the  fact  that  most  people  do  not  have  them.  This 
motive  is  not  always  a  conscious  one,  since  our  standards  of 
beauty  or  propriety  may  themselves  have  been  the  result  in 
part  of  this  desire  for  distinction.  Somewhat  similar  to  the 
desire  for  distinction  is  (4)  the  desire  for  power.  Men  like  to 
dominate  and  command  their  fellows,  and  this  want  may  be 
satisfied  by  means  of  the  dollar  as  well  as  with  the  sword ; 
hence  our  "  Napoleons  of  Finance,"  "  Captains  of  Industry,'* 
and  "  Railway  Kings." 

Again,  (5)  the  desire  for  activity  for  its  own  sake  may  be  men- 
tioned. Enforced  idleness  is  as  painful  as  prolonged  labor,  ex- 
cept to  the  degenerate.  This  desire  may  result  in  the  production 
of  goods,  but  almost  always  it  requires  the  use  of  goods 
:hat  have  been  produced ;  as,  for  example,  the  implements  of 
athletic  exercise.  Finally,  (6)  religion  and  the  ethical  sense 
may  be  important  factors  in  controlling  the  economic 
activity  of  the  individual.  Observe,  for  instance,  the  difference 
in  the  history  of  the  communistic  experiments  in  which  religious 
feeling  has  been  strong  and  those  in  which  it  has  been  weak. 

In  this  discussion  the  use  of  the  word  "  motive  "  must  not  be 
taken  to  mean  that  all  of  the  economic  life  of  the  individual 
is  a  consciously  rational  one,  in  which  pleasures  arc-  balanced 
against  pains  in  such  a  way  as  to  secure  the  maximum  surplus 


ELEMENTARY   CONCEPTS  105 

of  satisfactions.  Man  is,  it  is  true,  a  rational  being,  and  as 
such  pursues  definite  lines  of  action  under  the  influence  of  con- 
scious motives ;  but  he  is  also  a  creature  of  instincts  and  habits, 
and  much  of  the  economic  activity  of  the  individual  has  to  be 
interpreted  as  the  working  out  of  instinct  and  habit.  We  speak, 
for  example,  of  such  things  as  the  "  instinct  of  workmanship," 
the  "  habit  of  industry,"  the  "  habit  of  saving,"  and  the  like. 
The  foregoing  analysis  of  the  motives  in  economic  activity  is, 
however,  broad  enough  if  we  remember  that  "  pleasure  "  is 
something  that  is  not  always  consciously  sought,  but  is  often 
to  be  understood  as  the  result  of  the  functioning  of  inherited 
instincts  and  acquired  habits. 

Utility.  —  As  a  result  of  these  motives,  human  beings  are 
striving  for  the  possession  of  certain  things.  These  we  call 
goods.  To  understand  the  meaning  of  the  term  "  utility  "  in 
economics,  we  must  remember  that  economics  is  primarily  a 
science  of  man.  Goods  may  be  of  interest  in  chemistry  and 
physics  merely  as  things,  but  they  have  no  significance  what- 
ever in  economics  until  they  come  into  relation  with  man.  That 
fact  in  man  which  imparts  to  things  a  new  character  and  makes 
them  goods  is  the  fact  of  human  wants.  Anything  that  is  capa- 
ble of  satisfying  a  human  want  is  a  good,  and  possesses  utility. 

We  need  here  to  guard  against  a  misunderstanding  which  the 
word  "  utility  "  might  suggest.  Utility  is  the  power  to  satisfy 
wants,  not  the  power  to  confer  benefits.  Cigars  are  as  "  useful  " 
in  the  economic  sense  as  bread  or  books,  for  all  three  satisfy 
wants.  Economic  wants  may  be  serious,  frivolous,  or  even 
positively  pernicious,  but  the  objects  of  these  wants  all  alike 
possess  utility  in  the  economic  sense. 

Free  Goods  and  Economic  Goods.  —  But  it  is  apparent  that 
the  wants  we  have  mentioned  are  very  unlike  in  character.  Air 
and  water,  for  instance,  we  seldom  think  of  as  things  we  want 
at  all.  We  usually  have  them  in  abundance  and  without  exer- 
tion, so  that,  though  they  satisfy  wants  as  vital  as  any  we 
know,  we  seldom  spend  any  time  thinking  about  them  or  oui 
absolute  dependence  upon  them.  These  are  free  goods,  that  is, 
goods  that  exist  in  quantities  sufficient  to  supply  all  wants  for 


106  OUTLINES  OF  ECONOMICS 

them.  Land  in  a  new  country  is  frequently  a  free  good.  But 
the  list  of  things  that  are  free  is  quickly  exhausted.  Economic 
goods  are  those  which  exist  in  quantities  less  than  sufficient  to 
satisfy  all  wants  for  them.  Hence,  we  must  economize  in  the 
use  of  them,  are  willing  to  undergo  sacrifice  to  obtain  them, 
and  usually  they  are  obtained  only  by  exertion.  It  is,  however, 
their  scarcity  as  compared  to  the  human  wants  which  they  have 
the  power  to  satisfy,  and  not  the  fact  that  they  have  cost  labor, 
that  makes  them  economic  goods.  Land,  for  example,  a  free 
gift  of  nature,  is  one  of  the  most  important  of  economic  goods 
at  the  present  time. 

Effort.  —  Fortunately,  the  supply  of  economic  goods  can,  in 
most  cases,  be  increased  by  human  exertion  applied  to  the  ma- 
terials of  nature ;  but  this  exertion,  if  carried  beyond  a  certain 
point,  is  irksome,  and  this  has  an  important  effect  upon  the  con- 
duct of  life.  If  the  labor  force  of  the  community  were  unlimited, 
a  great  many  of  the  goods  which  we  now  use  sparingly  would  be 
as  free  as  air.  Idealists  have  pictured  for  us  a  condition  of  the 
future  where  a  few  hours'  work  per  day  for  each  individual  (an 
enjoyable  means  of  working  off  surplus  energy)  will  be  sufficient 
to  supply  us  with  all  of  the  goods  that  we  have  time  to  consume. 
At  present,  however,  most  of  us  find  that  our  consumption  is 
limited  by  the  pain  of  additional  effort.  The  end  of  our  eco- 
nomic activity  is,  therefore,  not  only  to  get  the  greatest  amount 
of  satisfaction,  but  also  to  minimize  the  amount  of  painful  labor. 

Waiting.  —  Another  fact  that  persists  in  our  economic  life 
is  the  necessity  for  waiting.  The  people  of  the  United  States 
wished  to  have  the  Panama  Canal,  but  they  could  not  get  it 
without  years  of  waiting.  They  were  obliged  to  spend  millions 
of  days  of  labor  with  no  benefit  in  return  for  a  long  time.  So 
in  general  the  production  of  goods  by  modern  methods,  involving 
the  investment  of  capital,  requires  waiting  as  well  as  effort. 

Risk.  —  In  a  society  characterized  by  private  enterprise  in 
industry,  the  risk  of  business  failure  is  an  important  fact. 
The  uncertainties  of  business  life  are  obvious :  A  factory  may  be 
destroyed  by  fire,  crops  may  be  destroyed  by  storm  and  hail, 
a  panic  may  destroy  credit  at  a  critical  moment,  fashions  may 


ELEMENTARY  CONCEPTS  107 

change,  or  competition  may  prove  too  strong.  Some  of  these 
uncertainties  may  be  eliminated  by  insurance,  but  others  can- 
not be  so  eliminated.  The  corporation  is  a  device  by  which 
the  risk  assumed  by  one  individual  is  limited,  although  not 
eliminated.  The  trust  and  the  monopoly  tend  to  reduce  the 
importance  of  the  factor  of  risk,  and  under  a  system  of  State 
socialism  it  might  possibly  become  a  negligible  factor  in  our 
daily  economic  life.  As  society  is  constituted  at  present,  how- 
ever, the  production  of  goods  to  satisfy  human  wants  is  attended 
by  risk,  and,  as  we  shall  see  later,  society  has  to  compensate 
those  who  take  these  inevitable  business  risks. 

Services.  —  Goods  have  been  commonly  divided  into  (1) 
material  things,  such  as  food,  clothes,  and  books,  and  (2)  personal 
services,  such  as  those  of  physicians,  lawyers,  musicians,  teach- 
ers, household  servants,  and  public  officers. 

The  advisability  of  the  distinction  has  been  denied.  Actors  and  singers, 
it  has  been  urged,  sell  us  perishable  material  things,  i.e.  light  and  sound 
waves  of  a  peculiar  kind.  A  recent  writer  also  considers  the  distinction  con- 
fusing because  it  obscures  the  fact  that  material  things  render  services  just 
as  human  beings  do.  The  piano  yields  services  as  does  the  singer.  From 
this  point  of  view  persons  are  durable  economic  goods  along  with  cattle  and 
wheelbarrows.  But,  on  whatever  ground  the  distinction  is  made,  it  is  im- 
portant to  recognize  that  among  the  things  that  contribute  to  our  well-being 
are  some  —  personal  services  — ■  that  are  so  perishable  that  they  must  be 
used  with  the  direct  cooperation  of  some  other  human  being,  while  in  other 
cases  the  services  are,  as  it  were,  stored  up  in  some  inanimate  material  things, 
and  the  relation  between  the  producer  and  consumer  becomes  an  impersonal 
one.  The  service  of  a  musician,  for  example,  is  personal  and  must  be  used 
the  moment  it  is  rendered;  the  purchase  of  a  musical  instrument,  on  the 
other  hand,  means  the  purchase  at  one  time  of  a  long  series  of  uses. 

Personal  Qualities  as  Goods.  —  The  central  point  in  our 
science  is  the  conception  of  man  in  his  relations  to  his  environ- 
ment, and  hence  it  does  not  seem  reasonable  to  include  the 
personal  qualities  of  men  under  the  head  of  goods.  Good  health 
and  technical  skill  make  a  man's  services  more  valuable  and 
assist  him  in  the  acquisition  of  wealth,  but  they  are  a  part 
of  him  rather  than  of  his  possessions.  It  is  his  services  that  he 
sells,  and  it  is  these  that  we  have  placed  under  the  head  of  goods. 


108  OUTLINES  OF  ECONOMICS 

When  we  consider  the  importance  of  the  priceless  heritage 
which  the  present  generation  has  received  in  the  shape  of  knowl- 
edge and  skill,  we  might  make  these  a  separate  category  as 
immaterial  goods. 

On  this  point  Professor  Marshall  says:  "German  economists  often  lay 
stress  on  the  non-material  elements  of  national  wealth ;  and  it  is  right  to  do 
this  in  some  problems  relating  to  national  wealth,  but  not  in  all.  Scientific 
knowledge,  indeed,  wherever  discovered,  soon  becomes  the  property  of  the 
whole  civilized  world,  and  may  be  considered  as  cosmopolitan  rather  than  a. 
specially  national  wealth.  The  same  is  true  of  mechanical  inventions  and 
of  many  other  improvements  in  the  arts  of  production;  and  it  is  true  of 
music.  But  those  kinds  of  literature  which  lose  their  force  by  translation 
may  be  regarded  as  in  a  special  sense  the  wealth  of  those  nations  in  whose 
language  they  are  written.  And  the  organization  of  a  free  and  well-ordered 
State  is  to  be  regarded  for  some  purposes  as  an  important  element  of  national 
wealth." » 

But  knowledge  does  not  exist  in  a  disembodied  state,  and  we 
shall  omit  nothing  and  avoid  some  confusion  if  we  divide  all 
goods  into  material  things  and  personal  services. 

Wealth  and  Income.  —  Wealth  may  be  looked  upon  either 
as  a  stock  of  things  on  hand  at  a  particular  time  or  as  a  flow  of 
things  during  a  period  of  time.  When  we  ask  how  much  a  man 
is  worth,  it  is  customary  in  America  to  answer  in  terms  of  the 
value  of  his  possessions,  while  an  Englishman  would  answer  in 
terms  of  annual  income.  The  two  ways  of  looking  at  the 
matter  are  not  identical,  however:  What  a  man  spends  in  a 
year  may  include  a  good  deal  spent  in  hiring  other  persons  to  do 
personal  service  for  him,  while  an  estimate  of  his  possessions 
could  not  include  the  value  of  those  persons  unless  they  were 
his  slaves. 

What  is  to  be  considered  as  a  man's  income  is  not  easy  to  say, 
as  our  law-makers  have  discovered  in  framing  income  tax  laws. 
In  economic  discussions  we  have  in  mind  net  and  not  gross 
income.  We  may  refer  to  the  economic  goods  and  services 
enjoyed  during  a  period  of  time,  to  the  satisfaction  derived 
from  these  goods  and  services,  or  to  their  money  value.  Money 
income  is  commonly  given  a  broader  meaning  to  cover  one's 

1  Principles  of  Economics,  6th  ed.,  p.  59. 


ELEMENTARY   CONCEPTS  109 

total  net  acquisition  of  money  regardless  of  whether  it  is  spent 
for  consumption  goods  or  is  saved. 

Individual  Wealth  and  Social  Wealth.  —  The  distinction 
between  the  social  and  the  individual  standpoint  meets  us  at 
many  points  in  the  study  of  economics.  That  which  is  wealth 
to  the  individual  is  often  not  wealth  to  society.  An  individual 
holding  a  government  bond  finds  that  he  can  exchange  it  for 
the  things  he  wants  almost  as  readily  as  though  it  were  gold  or 
some  other  commodity.  He  recognizes  that  the  paper  itself 
cannot  be  used  directly  for  any  useful  purpose,  yet  he  prizes 
it  because  it  represents  an  indisputable  claim  on  the  services 
or  commodities  of  other  people.  If  the  bond  should  be  destroyed, 
the  holder  as  an  individual  would  suffer  loss,  but  society  as  a 
whole  would  be  neither  richer  nor  poorer,  and  society,  exclusive 
of  the  bondholder,  would  have  gained  at  his  expense.  From 
the  social  standpoint  the  bond  is  not  wealth  at  all,  but  only  an 
evidence  of  a  legal  right  to  a  part  of  the  social  wealth.  All 
property  rights  are  simply  claims  to  a  part  of  the  social  wealth 
or  income.  The  claims  to  concrete,  material  things,  such  as 
farms  and  store  buildings,  are  included  by  an  individual  when 
he  enumerates  his  wealth;  and  farms  and  store  buildings  are 
social  wealth.  Again,  in  making  an  inventory  of  his  wealth, 
an  individual  would  not  ordinarily  include  such  an  item  as  the 
post  office,  which  is  public  and  not  private  property;  but, 
strictly  speaking,  the  post  office  is  owned  by  him  jointly  with 
other  members  of  society.  A  successful  patent  is  frequently 
looked  upon  as  an  item  of  wealth,  but  it  is  simply  a  means  by 
which  the  owner  gets  more  from  other  people  in  return  for  his 
services.  If  the  patent  is  declared  invalid,  others  gain  what  he 
loses  (not  counting  the  lessening  of  the  inducements  to  inven- 
tion). Again,  "  good  will  "  in  business  is  frequently  paid  for 
as  though  it  was  an  economic  good,  and  is  wealth  from  the 
individual  point  of  view,  but  it  is  not  social  wealth.  If  a  busi- 
ness man  loses  his  established  trade,  his  competitors  are  the 
gainers ;  society  as  a  whole  is  not  affected. 

Wealth  and  Value.  —  In  the  preceding  paragraphs  wealth  has 
been  spoken  of  as  consisting  of  particular  things.    A  lead  pencil 


HO  OUTLINES  OF  ECONOMICS 

and  the  year's  crop  of  wheat  are  both  wealth.  How  shall  we 
measure  the  amount  of  wealth  that  these  objects  represent? 
Since  the  items  of  wealth  are  composed  of  very  heterogeneous 
objects,  we  cannot  use  such  units  of  measure  as  bushels,  pounds, 
or  feet.  We  must  select  a  measure  that  has  reference  to  some 
quality  common  to  all  kinds  of  wealth.  Such  a  quality  is 
value.  This  is  a  subject  which  will  be  discussed  in  detail  later, 
the  valuation  of  goods  and  personal  services  being  the  central 
problem  in  economic  theory. 

Capital  and  Other  Forms  of  Wealth.  —  Some  material  things, 
as  well  as  personal  services,  yield  satisfaction  to  human  beings 
directly.  From  clothes,  dwellings,  food  upon  the  table,  musi- 
cal instruments,  and  the  like,  we  derive  enjoyment  directly. 
These  are  consumption  goods.  Other  goods  are  of  service  only 
indirectly.  A  plow,  we  say,  is  useful,  but  we  cannot  eat  or  wear 
it.  It  simply  helps  to  produce  the  things  that  we  can  enjoy. 
Such  articles  are  production  goods. 

The  distinction  is  a  matter  of  degree.  Even  the  food  upon  the  table  is  not 
quite  ready  to  be  enjoyed.  It  must  be  handled  with  knives  and  forks. 
This  has  led  some  writers  to  make  no  distinction  between  production  and 
consumption  goods.  But  it  has  been  pointed  out  that  great  differences  in 
degree  are  more  important  than  many  differences  in  kind.  The  distinction, 
it  may  also  be  noted,  is  not  made  on  the  ground  of  durability.  Consump- 
tion goods  —  a  painting  or  a  book,  for  example  —  may  be  very  durable. 

Production  goods,  again,  are  divided  into  capital  goods  and 
land .  Land  is  a  gift  of  nature ;  capital  goods  —  machinery, 
warehouses,  raw  material,  etc.  —  are  produced  by  man.  Other 
differences  between  these  two  classes  will  be  discussed  later. 

Capital  Goods  and  Capital  Value.  —  Capital  goods,  as  well  as 
other  forms  of  wealth,  are  of  such  a  heterogeneous  nature  that 
we  cannot  measure  them  by  such  units  as  pounds  or  inches. 
Here,  again,  we  must  select  some  quality  that  is  common  to  al! 
of  them,  which  is  value,  and  this  can  be  measured  in  terms  of 
dollars.  Very  frequently  the  value  of  capital  goods  is  confused 
with  the  concrete  good  itself.  A  typewriter  is  a  tangible,  ma- 
terial capital  good ;  its  weight  is  measured  by  pounds ;  its  bulk 
by  cubic  inches ;  its  value  by  dollars.     In  this  book  the  word 


ELEMENTARY  CONCEPTS 


III 


"  capital  "  is  frequently  used  as  a  short  expression  for  either 
of  the  phrases  "  capital  goods  "  and  "  capital  value,"  but  it 
will  always  be  clear  from  the  context  which  is  meant. 

Social  and  Individual  Capital.  —  The  individual  may  include 
items  in  an  enumeration  of  his  capital  which  are  not  capital 
from  the  standpoint  of  society.  The  landlord  who  has  dwell- 
ings to  let  regards  them  as  part  of  his  capital,  but  from  the  social 
standpoint  they  are  consumption  goods.  We  may  call  such 
goods  acquisitive  capital.  Again,  a  street  railway  may  consider 
its  franchise  as  a  part  of  its  capital,  but  from  the  social  stand- 
point a  franchise  is  not  capital  at  all,  nor  even  wealth,  but  is 
simply  a  right  to  use  the  streets  in  a  certain  manner.  Destroy 
the  franchise,  and  social  capital  would  not  be  lessened,  except, 
perhaps,  in  indirect  ways. 

Figure  i  will  help  to  make  these  various  distinctions  clear : 

Circle  AB  represents  goods. 

Circle  AC   represents   economic 
goods. 

Circle  AE  represents  producer's 
goods. 

Circle  AF  represents  land. 

Zone  BC   represents  free  goods. 

Zone  CE  represents  consumer's 
goods. 

Zone  DE  represents   acquisitive 
capital. 

Zone  EF  represents  social  capi- 
tal. 

Fig.  i. 

The  National  Wealth  and  the  National  Dividend.  —  Attempts 
have  been  made  to  ascertain  the  total  wealth  of  a  nation.  The 
latest  estimate  made  for  the  United  States  by  the  census  authori- 
ties is  given  on  the  following  page. 

Such  a  table  is  useful,  even  though  it  may  contain  some  rather 
arbitrary  estimates,  as  showing  the  relative  importance  of  dif- 
ferent classes  of  our  material  equipment.  Notice  the  small  total 
value  of  the  metals  used  as  money  and  the  relatively  large  value 
imputed  to  rea,]  property.     It  is  rather  surprising  that  manu 


112 


OUTLINES  OF  ECONOMICS 


facturing  machinery,  tools,  and  implements  are  worth  less  than 
our  live  stock.  But  great  care  should  be  taken  in  comparing 
the  total  wealth  as  estimated  in  this  and  in  preceding  census 
valuations  and  in  drawing  conclusions  as  to  the  significance  of  a 
growth  in  national  wealth  measured  in  dollars. 

Estimates  of  Wealth  for   1912  and  1900 


Form  of  Wealth 


Total $187,739,071,090 


Real  property  and  improvements  taxed 
Real  property  and  improvements  exempt 

Live  stock 

Farm  implements  and  machinery  .  . 
Manufacturing    machinery,    tools,    and 

implements 

Gold  and  silver  coin  and  bullion  .  .  . 
Railroads  and  their  equipment  .  .  . 
Street  railways,  etc. : 

Street  railways 

Telegraph  systems        

Telephone  systems        

Pullman  and  other  cars  not  owned  by 
railroads 

Shipping  and  canals 

Irrigation  enterprises 

Privately  owned  waterworks      .     .     . 

Privately  owned  central  electric  light 

and  power  stations 

All  other : 

Agricultural  products        

Manufactured  products 

Imported  merchandise 

Mining  products 

Clothing  and  personal  adornments 

Furniture,  carriages,  and  kindred 
property 


98,362,813,569 

12,313,519,502 

6,238,388,985 

1,368,224,548 

6,091,451,274 

2,616,642,734 

16,148,532,502 

4,596,563,292 

223,252,516 

1,081,433,227 

123,362,701 

1,491,117,193 

360,865,270 

290,000,000 

2,098,613,122 

5,240,019,651 

14,693,861,489 

826,632,467 

815,552.233 
4,295,008,593 

8,463,216,222 


5,5I7,3o6,775 


46,324,839,234 

6,212,788,930 

3,306,473,278 

749,775,970 

2,541,046,639 
1,677,379,825 
9,o35,732,ooo 

1,576,197,160 
211,650,000 
400,324,000 

98,836,600 
537,849,478 

267,752,468 

402,618,653 

1,455,069,323 

6,087,151,108 

424,970,592 

326,851,517 

2,000,000,000 

4,880,000,000 


In  addition  to  the  difficulty  of  getting  accurate  information 
on  these  various  items,  there  are  several  things  to  be  kept  in 
mind  in  making  use  of  such  an  estimate.  First,  the  returns  are 
made  in  money,  so  that  fluctuations  in  the  value  of  money  will 
show  a  change  in  the  total  valuation  even  if  there  is  no  real 
change  in  the  relation  between  the  wants  of  a  community  and  its 


ELEMENTARY  CONCEPTS 


"3 


supply  of  goods.  Again,  free  goods  are  not  included  in  such 
an  estimate.  Also,  a  good  deal  of  public  property  does  not  have 
a  money  estimate  put  upon  it.  Who  would  attempt  to  say  what 
our  rivers  and  harbors  are  worth,  and  yet  why  should  not  these 
be  included  in  the  estimate  if  our  canals  are  ? 

It  seems  that  much  that  is  included  in  the  estimate  is  wealth 
from  the  individual  standpoint  only,  but  not  from  the  social,  as 
in  the  case  of  the  valuation  of  a  business  whose  value  consists 
largely  of  patents  or  monopolistic  privileges.  In  the  table  above, 
for  example,  the  value  of  railway  property  was  obtained  by  capi- 
talizing railway  earnings.  Is  this  sum  properly  included  in  an 
estimate  of  the  total  amount  of  wealth  in  the  United  States? 
The  inclusion  is  proper  if  we  are  confining  ourselves  to  a  state- 
ment of  the  sum  of  the  values  of  property  rights,  but  it  is  mis- 
leading if  we  wish  to  show  the  relative  importance  of  railways 
and  of  property  in  a  competitive  industry,  or  if  we  are  discussing 
railways  in  relation  to  the  public  welfare.  A  similar  line  of 
thought  is  suggested  with  reference  to  land  values.  Ten  years 
ago  we  had  about  the  same  area  and  the  same  quality  of  land 
as  we  now  have,  so  that  its  high  value  today  cannot  mean  that 
we  are  better  equipped  with  natural  resources. 

We  must  be  on  our  guard  against  attaching  improper  signifi- 
cance to  estimates  of  total  wealth.  Changes  in  total  value  are 
not  an  accurate  index  of  changes  in  well-being.  It  is  possible 
that  an  increase  in  concrete  material  goods  will  actually  decrease 
the  total  quantity  of  wealth  measured  in  dollars.  A  hundred 
bushels  of  wheat  at  $i  per  bushel  have  a  higher  selling  value 
than  two  hundred  bushels  at  40  cents  per  bushel.  If  by  some 
magical  process  all  goods  could  be  made  free  as  air,  there  would 
be  no  value  whatever.  An  estimate  of  the  value  of  our  stock  of 
wealth  also  necessarily  omits  to  take  account  of  personal  serv- 
ices. It  is  obvious  also  that  per  capita  wealth  has  more 
significance  for  well-being  than  has  total  wealth.  Individual 
wealth  and  value  connote  scarcity ;  well-being  implies  abun- 
dance. Nevertheless,  under  present  conditions,  it  is  probable 
that  an  increase  in  per  capita  individual  wealth,  when  not  due 
to  fluctuations  in  the  value  of  money,  also  indicates  an  increase 
1 


114  OUTLINES  OF  ECONOMICS 

in  well-being.  There  is  no  likelihood  of  our  being  able  to  in- 
crease the  quantity  of  economic  goods  to  such  an  extent  as  to 
render  them  free  and  hence  valueless ;  and,  on  the  other  hand, 
as  will  be  more  fully  explained  later,  new  wants  are  constantly 
developing,  and  value  springs  from  the  power  to  minister  to 
unsatisfied  wants. 

The  national  income  is  a  concept  which  takes  account  of  the 
services  rendered  directly  by  persons  as  well  as  of  the  material 
things  that  are  used.  The  national  income,  objectively  consid- 
ered, is  a  gigantic  stream  of  food,  clothes,  comforts,  personal  serv- 
ices, etc.,  which  is  used  up  in  the  direct  satisfaction  of  wants  in  a 
specified  period,  such  as  a  year,  by  the  millions  of  individual 
acts  of  consumption.  Some  writers  would  include  also  the 
additions  to  our  industrial  equipment,  such  as  new  machines ; 
but  these  may  be  regarded  as  promises  of  an  enlarged  future  in- 
come of  society,  not  as  part  of  its  present  real  income.  Thus 
we  may  distinguish  between  the  annual  national  product  and  the 
annual  national  income. 

It  has  been  estimated  that  the  average  income  per  family 
was  about  $1500  in  the  United  States  in  1910.1  The  margin  of 
error  in  this  average  may  be  very  great,  but  even  if  it  could  be 
taken  as  accurately  measuring  the  per  family  income  of  that 
year,  it  would  not  necessarily  be  an  index  of  how  well  we  might 
live  under  some  organization  of  society  that  attempted  an  equal 
or  nearly  equal  distribution  of  income.  The  effect  upon  the 
efficiency  of  management,  the  hours  of  labor,  and  the  intensity 
of  effort  might  be  disastrous.  On  the  other  hand,  there  might 
be  much  saving  from  an  elimination  of  wasteful  and  unnecessary 
expenditure  without  a  reduction  of  real  enjoyment,  and  there 
might  be  a  fuller  utilization  of  productive  forces  now  going 
to  waste.     We  refrain  from  entering  this  realm  of  speculation. 

The  national  income  may  be  looked  upon  as  the  national 
dividend,  the  sum  total  of  good  things  to  be  divided  among  the 
various  families  or  individuals.  The  forces  determining  the 
size  of  this  dividend  and  the  manner  of  its  division  are  the 
main  topics  for  discussion  in  political  economy. 

1  W.  I.  King,  The  Wealth  and  Income  of  the  People  of  the  United  Slates,  Chap.  ix. 


ELEMENTARY  CONCEPTS  115 

QUESTIONS   AND   EXERCISES 

1.  Does  the  following  statement  agree  with  the  definitions  in  the  text? 
"The  true  basis  for  an  estimate  of  a  nation's  wealth  is  to  be  found  in  the  en- 
joyments of  its  members."     Hadley,  Economics,  p.  4. 

2.  Are  the  following  wealth  :  air?  whisky?  a  copyright?  Lake  Michigan? 
skill  as  a  carpenter?  good  health? 

3.  Discuss  the  following:  "Among  the  motives  which  lead  men  to 
(accumulate  wealth,  the  primacy,  both  in  scope  and  intensity,  therefore, 
continues  to  belong  to  this  motive  of  pecuniary  emulation."  Veblen, 
Theory  of  the  Leisure  Class,  p.  34. 

4.  State  the  significance  of  the  following :  "A  horse  is  not  wealth  to  us  if 
we  cannot  ride,  nor  a  picture  if  we  cannot  see,  nor  can  any  noble  thing  be 
wealth  except  to  a  noble  person."     Ruskin,  Munera  Pulveris,  p.  10. 

5.  Discuss  the  following  statement :  "In  1770  Arthur  Young  reckoned  the 
income  of  England  to  be  £120,000,000;  in  1901  the  income  may  be  roughly 
set  down  at  £1,600,000,000.  Making  correct  allowances  for  population 
and  for  prices,  this  growth  of  income  would  signify  a  large  increase  of  com- 
modities per  head ;  but  would  it  tell  us  that  we  are  working  and  living  some- 
.vhat  better  than  our  ancestor??"     Hobson,  The  Social  Problem,  p.  43. 

6.  How  does  the  Federal  Income  Tax  law  (as  interpreted  by  the  Treasury 
Department)  define  a  person's  income? 

REFERENCES 

Cannan,  Edwin.    Wealth,  Chap.  i. 

Clark,  J.  B.     The  Philosophy  of  Wealth,  Chaps,  i  and  iii. 

Ely,  R.  T.     Property  and  Contract,  Vol.  i,  Chap.  iii. 

Fisher,  Irving.     The  Nature  of  Capital  and  Income,  Chaps,  i  and  ii. 

Hadley,  A.  T.     Economics,  pp.  1-10. 

Hobson,  J.  A.     The  Social  Problem,  Book  i,  Chap.  ii. 

King,  W.  I.     The  Wealth  and  Income  of  the  People  of  the   United  States, 

Chaps,  ii  and  v. 
Leslie,  T.  E.  C.    Essays  in  Political  Economy,  Chap.  i. 
Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Book  ii. 
MiTcnELL,   W.    C.     "Human   Behavior   and   Economics:    A   Survey  of 

Recent  Literature,"  Quarterly  Journal  of  Economics,  Vol.  xxix,  pp.  1-47. 
PiGOU,  A.  C.     Wealth  and  Welfare,  Part  i,  Chaps,  i  and  ii. 
Ruskin,  John.     Munera  Pulveris,  Chap.  i. 

Sdjgwick,  Henry.     The  Principles  of  Political  Economy,  Book  i,  Chap.  iii. 
Smart,  William.     Studies  in  Economics,  Chap,  viii;    and  Distribution  of 

Income,  Book  ii. 
Taussig,  F.  W.    Principles  of  Economics,  Vol.  i,  Chap.  i. 
Veblen,  Thorstein.     The  Theory  of  the  Leisure  Class,  esp.  pp.  24-34 ;  and 

The  Instinct  of  Workmanship,  Chap.  i. 
Special  Census  Reports  on  Wealth,  Debt,  and  Taxation, 


CHAPTER  VIII 
PRODUCTION 

Production  Defined.  —  Man  creates  no  new  matter.  Neither 
the  farmer  nor  the  merchant  adds  one  atom  to  the  existing 
material  of  the  earth.  Yet  they  are  both  properly  called  pro- 
ducers because  they  increase  economic  utility.  Production, 
then,  means  the  creation  of  economic  utilities  by  the  application 
of  man's  mental  and  physical  powers  to  the  materials  of  nature. 
The  act  of  production  can  be  reduced  to  the  following  three 
operations :  (i)  changing  the  form  of  things,  or  combining  or 
rearranging  them,  (2)  changing  their  place,  and  (3)  keeping 
them  until  such  times  as  they  are  wanted ;  in  other  words, 
production  adds  to  the  materials  of  nature,  form  or  composition 
utility,  time  utility,  and  place  utility.  Production  thus  denned 
includes  the  rendering  of  direct  personal  services. 

It  has  seemed  to  some  that  the  farmer  is  more  truly 
a  producer  than  the  manufacturer,  and  the  manufacturer  than 
the  merchant;  but  such  is  not  at  all  the  case.  All  of  these 
industrial  classes  help  at  some  stage  in  the  process  of  getting 
the  materials  of  nature  ready  for  consumption.  The  miner 
gets  iron  ore  from  the  ground,  the  manufacturer  transforms 
it  into  stoves,  the  railway  company  transports  them,  and  the 
merchant  acquires  a  stock  of  them  and  keeps  them  until  they 
are  wanted.  One  stage  is  as  essential  as  another  if  wants  for 
stoves  are  to  be  satisfied.  It  may  well  happen  that  the  utilities 
produced  by  the  merchant  could  be  produced  with  a  smaller 
expenditure  of  economic  force,  and  that  by  a  better  organization 
of  the  factors  of  production  saving  could  be  effected ;  but  this 
is  no  justification  whatever  for  the  popular  impression  that  he  is 
not  a  productive  worker.  Things  are  not  fully  "  produced  " 
until  they  are  in  the  form  in  which  they  are  wanted,  at  the  place 
at  which  they  are  wanted,  and  at  the  time  when  they  are  wanted. 

ji6 


PRODUCTION  1 1 7 

In  books  on  political  economy  we  are  likely  to  find  that  much 
more  is  said  about  the  distribution  of  wealth  than  specifically 
about  its  production.  The  reason  for  this  is  partly  that  the 
problems  of  production  are  to  a  very  considerable  extent  a 
matter  of  technical  progress.  How  to  increase  the  yield  per 
acre  is  not  specifically  an  economic  problem.  Nevertheless 
the  economist  is  interested  in  the  volume  of  production  compared 
with  the  growth  in  population  and  in  changes  in  the  character 
of  production.  Misdirected  production  is  thought  to  have  some- 
thing to  do  with  economic  crises,  and  changes  in  the  production 
of  gold  may  explain  widespread  changes  in  prices,  so  that 
production  has  in  reality  received  a  good  deal  of  attention  from 
economists  in  connection  with  their  discussion  of  other  sub- 
jects. In  this  book,  for  example,  the  relation  of  population  to 
agriculture  is  considered  in  the  chapter  on  Wages. 

The  close  relation  between  production  and  distribution  may  be 
further  illustrated  by  the  subject  of  "  scientific  management  " 
in  industry.  This  means  such  an  arrangement  of  work,  selection 
of  methods,  and  measuring  of  individual  efficiency  within  a 
factory  or  elsewhere  as  to  produce  the  maximum  output  per 
man.  Take  the  simple  operation  of  shoveling  coal  or  cinders, 
where  this  must  be  done  by  hand.  It  has  been  found  that  the 
amount  handled  per  day  per  man  will  depend  on  the  weight  of 
the  shovel,  its  size,  the  amount  taken  at  each  lift,  and  the  number 
of  movements  per  hour.  The  largest  shovelful  is  not  likely  to 
be  the  most  economical.  Such  inquiries  obviously  have  a  rela- 
tion to  the  wages  which  may  equitably  be  paid  to  different 
workmen,  and  representatives  of  trade  unions  have  looked  upon 
the  movement  toward  the  utilization  of  scientific  management 
with  considerable  suspicion  and  hostility  as  a  system  of  driv- 
ing men  to  greater  exertion.  It  would  seem  that  if  there  is 
cooperation  between  managers  and  trade  union  officials,  total 
production  may  be  increased  and  wages  may  be  increased  by 
scientific  management  without  detriment  to  the  individual 
workingman. 

On  the  whole,  it  is  probably  true  that  the  subject  of  production 
has  in  recent  years  been  unduly  neglected  by  economists.     The 


Il8  OUTLINES  OF  ECONOMICS 

conservation  movement,  looking  toward  the  less  wasteful  utiliza- 
tion of  our  natural  resources,  had  its  origin  outside  of  economic 
circles.  In  recent  years,  however,  the  economists  are  very 
properly  placing  more  emphasis  upon  the  obvious  fact  that 
economic  progress  depends  upon  increasing  the  annual  per 
capita  production  of  wealth  as  well  as  upon  improving  the  way 
in  which  wealth  is  distributed  among  its  producers. 

The  Production  of  Values.  —  We  have  said  that  production 
means  the  increasing  of  economic  utility.  This  is  precisely 
equivalent  to  saying  that  it  means  the  rendering  of  services 
that  lead  directly  or  indirectly  to  the  satisfaction  of  human 
wants.  And  since  we  are  not  willing  to  pay  for  things  that  we 
do  not  want,  it  follows  that  every  service  for  which  we  are 
willing  to  pay  must  be  classed  as  productive.  All  money-mak- 
ing pursuits  are,  therefore,  productive.  Except  through  in- 
heritance or  gift  or  gambling  or  fraud  or  theft  one  cannot  gain 
an  income  unless  one  gives  a  quid  pro  quo  by  rendering  productive 
services  or  by  permitting  the  use  of  some  productive  agent 
which  one  owns  or  controls.  But  it  does  not  follow  that 
money-making  is  a  measure  or  gauge  of  the  amount  of  productive 
service  rendered  or  that  production  and  acquisition  always  go 
hand  in  hand.  For  the  amount  of  money  that  will  be  paid  for 
commodities  and  services  will  depend  upon  their  value  rather 
than  upon  their  utility ;  and  scarcity,  as  well  as  utility,  is  a 
factor  in  determining  the  value  of  things. 

Men  can  sometimes  increase  the  value  of  things  by  curtailing 
the  supply  of  them,  although,  of  course,  this  decreases  their 
aggregate  utility.  In  the  case  of  a  monopoly,  where  the  power 
to  control  the  supply  of  a  product  is  lodged  in  the  hands  of  a 
single  producer  or  group  of  producers,  this  often  becomes  a 
matter  of  much  importance.  The  case  of  the  Dutch  East 
India  Company,  which  is  said  to  have  destroyed  half  of  its 
spice  crop,  because  the  remaining  half  would  have  a  greater 
value  than  the  whole  would  have  had,  has  been  cited  by  many 
economists.  In  some  fishing  centers  part  of  an  unusually  large 
catch  is  destroyed  or  sold  as  fertilizer  in  order  that  the  market 
price  may  not  be  unduly  lowered.     Most  commonly,  of  course, 


PRODUCTION  119 

limitation  of  supply  is  effected  by  merely  producing  less  than 
might  have  been  produced  and  sold  at  a  price  high  enough 
to  cover  expenses.  In  competitive  enterprises,  however,  no 
one  producer  can  control  the  supply  of  the  product,  so  that  in 
general  the  only  way  in  which  a  producer  can  increase  the  value 
of  his  output  is  by  increasing  its  quantity  and,  consequently, 
its  utility.  But  it  should  be  clear  that  we  may  get  very  different 
results  if  we  measure  the  results  of  productive  effort  in  terms  of 
values  from  what  we  should  get  if  we  used  utility  as  our  measure. 
From  the  point  of  view  of  social  welfare,  the  production  of 
utilities  is,  of  course,  what  we  are  interested  in.  But  we  have 
to  recognize  that  in  our  modern  exchange  economy  the  produc- 
tion of  values  is  what  producers  are  mainly  interested  in.  In 
later  chapters  we  shall  have  to  consider  more  carefully  the 
extent  to  which  these  two  principles  of  production  are  in  har- 
mony, and  the  ways  in  which-  they  are  in  conflict.1 

Factors  of  Production.  —  It  has  been  customary  to  speak  of 
three  factors  of  production  —  nature,  labor,  and  capital.  Under 
nature  are  included  all  forces  external  to  man,  as  the  wind,  the 
movement  of  water,  attraction  of  gravitation,  cohesion,  etc. 
Frequently  these  things  furnished  by  nature  are  called  simply 
land,  because,  of  what  belongs  to  external  nature,  it  is  with  land 
that  we  have  principally  to  do  in  political  economy. 

Of  the  total  land  surface  of  the  United  States  all  but  about 
15  per  cent  had  been  appropriated  or  reserved  in  19 13.  The 
unappropriated  and  unreserved  portions  were  largely  in  Nevada, 
Arizona,  Wyoming,  and  New  Mexico.  Of  the  total  land  sur- 
face, 46.2  per  cent  was  in  farms  in  1910,  and  of  these  farms  only 
54.4  per  cent  consisted  of  improved  land;  that  is,  only  25.1 
per  cent  of  the  total  land  area  was  improved  farm  land.  "  Im- 
proved farm  land  includes  all  land  regularly  tilled  or  mowed, 
land  pastured  and  cropped  in  rotation,  land  lying  fallow,  land 
in  gardens,  orchards,  vineyards,  and  nurseries,  and  land  occupied 
by  farm  buildings."     If  all  of  the  improved  land  were  equally 

1  In  a  literal  sense  neither  utility  nor  value  is  "produced."  The  things  produced 
»«  i-ouimodities  and  services,  which  have  utility  and  value  because  they  satisfy 
hv.man  wants  that  would  otherwise  be  unsatisfied. 


120 


OUTLINES  OF  ECONOMICS 


distributed,  there  would  be  about  five  acres  for  each  person  in 
the  United  States.  This  figure  has  decreased  slightly  in  the 
last  quarter  of  a  century,  although  the  historical  comparison  is 
made  somewhat  uncertain  by  the  fact  that  woodland  at  the 
census  of  1900,  1890,  and  1870  was  included  in  improved  land, 
but  was  not  so  included  in  1880  and  1910.  The  production  of 
the  leading  cereals  per  acre  has  not  changed  much  since  1890 
and  on  the  whole  the  per  capita  production  of  wheat  and  corn 
measured  in  bushels  has  not  increased  since  1880. 

In  other  lines  of  production  the  per  capita  story  is  quite  dif- 
ferent, as  will  be  seen  from  the  following  table : 


Per  Capita  Production  of  Selected  Commodities1 
1880-1913 


Commodity 

1880 

1890 

1900 

1910 

igi3 

Per  Capita 

Wheat  production  —  bushels      .     . 

8.992 

7-732 

8-325 

7-352 

7.868 

Corn  production  —  bushels    .     .     . 

29.769 

29.483 

26.722 

30-34I 

25.220 

Number  of  cattle  on  farms     .     .     . 

.663 

.824 

.676 

.716 

•583 

Coal  production  —  long  tons      .     . 

1-378 

2.257 

3-145 

4.671 

Cotton  production  —  500  lb.  bales 

.114 

.123 

.136 

.144 

.152 

Pig  iron  production  —  long  tons 

.074 

.129 

.192 

.266 

•319 

Ton-miles  of  freight 

1227 

1799 

2626 

3106 

Labor,  as  a  factor  of  production,  includes  human  activities  of 
every  sort,  intellectual  as  well  as  physical,  which  have  economic 
significance.  We  might  better,  perhaps,  substitute  man  for 
labor  as  the  second  factor.  Labor  is  supplied  by  human  beings 
and  is  different  from  material  goods  because  it  is  always  con- 
nected with  a  personality.  Moral  and  intellectual  qualities 
increase  its  productiveness.  Temperance,  trustworthiness, 
skill,  alertness,  quick  perception,  a  comprehensive  mental  grasp, 
—  all  these  and  other  qualities  belonging  to  the  soul  of  man  are 
of  paramount  importance.  Man's  mere  physical  strength  in 
itself  is  a  poor  thing,  being  surpassed  by  that  of  the  lower  animals, 

1  Compiled  from  "  Statistical  Record  of  the  Progress  of  the  United  States,  1800  to 
1913,"  in  Statistical  Abstract  of  the  United  Slates,  1913.  Where  possible,  five-year 
averages  have  been  used  with  the  census  year  as  the  center. 


PRODUCTION  121 

but  man  is  far  more  productive,  and  even  as  a  slave  sold  for 
more  than  the  lower  animals. 

Man  can  get  but  little  directly  from  nature  with  his  unaided 
hands.  The  instruments  which  assist  him,  as  we  have  seen, 
are  called  capital;  in  other  words,  capital  is  every  product  which 
is  used  or  held  for  the  purpose  of  producing  or  acquiring  wealth. 
By  this  definition,  land  is  evidently  excluded  from  the  category. 
The  nation's  capital,  then,  consists  of  tools,  machinery,  busi- 
ness buildings,  transportation  systems,  raw  material,  etc.1 
Capital  cannot  be  looked  upon  as  an  independent  factor  of 
production,  since  it  is  derived  from  the  labor  of  man  applied  to 
nature.  This  fact  has  led  some  persons  to  say  that  capital  is 
simply  stored-up  labor,  but  this  overlooks  the  important  ele- 
ment of  time  required  for  production  with  the  aid  of  capital. 
When  we  say  that  to  print  a  book  according  to  present-day 
methods  requires  the  cooperation  of  labor  and  capital,  we  do 
not  deny  that  the  type-setting  machines  and  printing  presses 
which  are  used  are  themselves  the  product  of  other  kinds  of 
labor  applied  to  nature.  To  substitute  capital  for  labor  may 
seem  to  be  simply  substituting  one  kind  of  labor  for  another. 
But  a  long  time  elapses  between  the  digging  of  the  iron  ore  and 
the  actual  using  of  the  machines  in  printing,  and  this  means 
waiting  for  results  on  the  part  of  some  one.  Capitalistic  produc- 
tion, as  distinct  from  simple  hand  labor,  is  merely  a  different 
method  —  a  roundabout  method  —  of  applying  human  labor 
to  the  materials  of  nature.  It  is  this  time  element  which  gives 
rise  to  the  problem  of  interest  to  be  discussed  in  a  later  chapter. 

"Capital  is  an  intermediate  product  of  nature  and  labor,  nothing  more. 
Its  own  origin,  its  existence.  :ts  subsequent  action,  are  nothing  but  stages  in 
the  continuous  working  of  the  true  elements,  nature  and  labor.  They,  and 
they  alone,  do  everything  from  beginning  to  end  in  bringing  consumption 
goods  into  existence.  The  only  distinction  is  that  sometimes  they  do  it  all 
at  once,  sometimes  by  several  stages.  In  the  latter  case  the  completion  of 
each  stage  is  marked  outwardly  by  the  appearance  of  a  fore-product  or  inter- 
mediate product,  and  capital  has  emerged.     But,  let  me  ask,  is  a  thing  any 

1  We  may  here  again  caution  the  reader  against  confusing  these  concrete  goods 
with  their  value.  A  factory  building  might  sell  for  $100,000,  but  the  capital  is  the 
building  itself,  not  its  money  value. 


122  OUTLINES  OF  ECONOMICS 

the  less  the  work  of  its  author  that  it  is  not  produced  all  at  once,  but  in  in- 
stallments? If  today,  by  allying  my  labor  with  natural  powers,  I  make 
bricks  out  of  clay,  and  tomorrow,  by  allying  my  labor  with  natural  gifts, 
I  obtain  lime,  and  the  day  after  make  mortar  and  so  construct  a  wall,  can  it 
be  said  of  any  part  of  the  wall  that  I  and  the  natural  powers  have  not  made  it  ? 
Again,  before  a  lengthy  piece  of  work,  such  as  the  building  of  a  house,  is 
quite  finished,  it  must  naturally  be  at  one  time  a  fourth  finished,  then  a  half 
finished,  then  three  quarters  finished.  What,  now,  would  be  said  if  one  were 
to  describe  these  inevitable  stages  of  the  work  as  independent  requisites  of 
house-building,  and  maintain  that,  for  the  building  of  a  house,  we  require, 
besides  building  materials  and  labor,  a  quarter-finished  house,  a  half- 
finished  house,  a  three-quarters  finished  house?  In  form  perhaps  it  is 
less  striking,  but  in  effect  it  is  not  a  whit  more  correct,  to  elevate  those 
intermediate  steps  in  the  progress  of  the  work,  which  outwardly  take  the 
shape  of  capital,  into  an  independent  agent  of  production  by  the  side  of 
nature  and  labor."  x 

For  some  purposes  it  is  important  to  distinguish  fixed  capital, 
which  lasts  for  a  succession  of  operations,  from  circulating 
capital,  which  is  used  up  in  one  act  of  production.  Coal  used 
in  a  locomotive  is  an  example  of  circulating  capital;  the  car 
in  which  the  coal  is  hauled  is  fixed  capital.  The  difference 
is  one  of  degree  only.2 

Saving  and  Capital  Formation.  —  From  the  individual  stand- 
point, saving  means  the  postponement  of  consumption.  To 
lend  to  another,  and  thus  secure  a  claim  on  his  services  for  the 
future,  is  an  act  of  individual  saving,  but  this  does  not  necessarily 
result  in  saving  from  the  social  standpoint.  An  act  can  be 
termed  social  saving  only  when  the  total  social  income  in  the 
future  will  be  increased  thereby.  It  is  conceivable  that  this 
might  take  the  form  of  merely  hoarding  up  finished  consumption 
goods  in  anticipation  of  a  famine,  but  that  is  not  the  kind  of 
saving  that  is  typical  of  modern  industrial  nations.     It  is  true, 

1  Bohm-Bawerk,  Positive  Theory  of  Capital  (trans,  by  W.  Smart),  p.  96. 

'  The  difference  between  fixed  and  circulating  capital  has  to  be  recognized  in 
the  accounting  systems  of  business  undertakings.  Since  the  unit  of  time  for  which 
accounting  attempts  to  state  costs  and  profits  accurately  is  usually  a  year,  items  of 
capital  which  are  ordinarily  acquired  and  disposed  of  ("turned  over")  within  a 
year  are  called  "current  assets,"  while  items  of  capital  whose  period  of  normal  use 
is  more  than  a  year  are  called  "capital  assets."  Both  kinds  of  assets  are,  of  course, 
capital  in  the  economic  sense,  except  that  land  is  always  included  in  "capital  assets." 


PRODUCTION 


123 


however,  that -we  frequently  produce  durable  consumption 
goods  which  will  be  used  for  a  long  time  in  the  future.  The 
construction  of  a  public  library  building  thus  involves  real 
social  saving. 

But  true  social  saving  may  also  take  the  form  of  bettering 
the  industrial  equipment  of  society.  To  provide  more  and 
better  machines  it  is  necessary  to  use  some  of  the  labor  which 
might  be  used  to  increase  our  present  income.  If  all  of  the 
labor  now  used  in  the  construction  of  new  milling  machinery, 
ovens,  etc.,  were  employed  in  turning  into  bread  all  of  the 
flour  we  now  have  on  hand,  we  could  doubtless  greatly  increase 
temporarily  our  present  income  in  bread,  but  it  would  be  at  the 
expense  of  the  future  income.  Thus  the  saving  which  results 
in  the  formation  of  social  capital  requires  two  things:  (1) 
abstaining  from  the  largest  possible  income  today,  and  (2) 
using  part  of  our  labor  in  bettering  the  industrial  equipment. 

Organization  of  the  Productive  Factors.  —  The  three  factors, 
land,  labor,  and  capital,  must  be  brought  together  for  purposes 
of  production.  In  the  case  of  many  farmers  and  small-scale 
manufacturers,  all  three  are  furnished  by  the  same  person,  but 
under  our  system  of  private  property,  a  marked  differentiation 
of  ownership  takes  place  as  industrial  development  becomes 
more  complex.  In  a  large-scale  establishment  it  is  the  ex- 
ceptional case  where  the  majority  of  the  laborers  have  any  share 
in  the  ownership  of  the  capital,  but  generally  the  owners  of  the 
capital  are  also  the  owners  of  the  land.  In  American  agri- 
culture, ownership  of  the  land  and  the  capital  by  the  same  person 
is  also  common,  but  in  England  at  the  present  time  it  is  the 
rule  that  the  landowner  and  farmer  are  different  persons.  On 
the  other  hand,  factories  are  frequently  built  upon  leased  ground, 
and  much  land  is  farmed  in  America  by  tenants  who  furnish 
their  own  capital.  Separation  in  the  ownership  of  the  produc- 
tive factors  makes  necessary  a  distinct  valuation  of  the  services 
of  each  one  of  the  factors. 

The  Entrepreneur,  or  Undertaker.  —  The  one  who  manages  a 
business  for  himself  was  formerly  called  an  undertaker,  or  ad- 
venturer, but  the  first  word  has  been  appropriated  by  one  small 


124  OUTLINES  OF  ECONOMICS 

class  of  business  men,  and  the  latter  has  acquired  a  new  mean- 
ing, carrying  with  it  the  implication  of  rashness  and  even 
dishonesty.  We  have  consequently  been  obliged  to  resort  to 
the  French  language  for  a  word  to  designate  the  person  who 
organizes  and  directs  the  productive  factors,  and  we  call  such  a 
one  an  entrepreneur.  The  entrepreneur  also  assumes  a  large 
measure  of  business  risks  and  uncertainties. 

The  function  of  the  entrepreneur  has  become  such  an  im- 
portant one  in  modern  society  that  it  is  often  convenient  to 
regard  him  as  a  fourth  factor  in  production,  distinct  from  other 
classes  of  laborers.  He  has  been  well  called  a  captain  of  in- 
dustry, for  he  commands  the  industrial  forces,  and  upon  him 
more  than  any  one  else  rests  the  responsibility  of  success  or 
failure.  A  business  which  has  achieved  magnificent  success 
often  becomes  bankrupt  when,  owing  to  death  or  other  causes, 
an  unfortunate  change  in  the  entrepreneur  is  made.  The 
prosperity  of  an  entire  town  has  sometimes  been  observed  to 
depend  upon  half  a  dozen  shrewd  captains  of  industry. 

Division  of  Labor.  —  A  characteristic  feature  of  the  organiza- 
tion of  the  factors  is  what  is  commonly  called  a  division  of  labor, 
but  this  term  suggests  a  number  of  related  ideas  which  must  be 
distinguished,  (i)  We  may  mention  first  a  separation  of  occupa- 
tions, each  one  being  independent  of  the  other,  as  is  shown,  for 
example,  in  the  splitting  up  of  medical  work  into  various  special- 
ties, and  again,  entirely  new  occupations  are  continually  appear- 
ing. (2)  We  also  find  production  divided  into  stages,  each 
one  giving  rise  to  a  commercial  product,  but  not  to  a  finished  con- 
sumption good.  This  becomes  clear  if  we  think  of  the  history 
of  almost  any  article  of  daily  use:  the  making  of  bread  pre- 
supposes the  flour  and  wheat  stages.  (3)  We  have  in  the  third 
place  what  is  most  commonly  referred  to  by  the  term  "  division 
of  labor,"  where  the  productive  process  is  divided  into  minute 
parts,  and  one  part  given  to  each  laborer.  The  organization 
of  a  cotton  mill  affords  an  excellent  illustration : 

In  cotton  mills,  as  in  all  other  textile  mills,  there  are  men  of  skill  and  ex- 
perience who  superintend  or  oversee  the  work  in  various  buildings  and  in 
the  rooms  and  yards.    These  supervisory  employees  have  assistants,  and 


PRODUCTION  1 2  iy 

the  division  of  superintendence  is  carried  down  to  the  sections  of  rooms,  so 
that  all  sections  have  their  supervisors,  known  variously  as  section  bosses, 
section  hands,  section  girls,  and  third  hands.  The  following  list  of  occupa- 
tions will  indicate  the  extent  to  which  division  of  labor  is  carried  in  this 
industry :  alley  boys  (or  girls) ;  bundle  boys ;  filling  and  roving  carriers ; 
belt  makers,  blacksmiths,  carpenters,  machinists,  masons,  painters,  steam 
fitters,  and  other  mechanics,  including  sometimes  electricians  and  battery- 
men  ;  roll  coverers ;  helpers ;  laborers  (unskilled) ;  bale  openers ;  picker 
hands  or  cotton  shakers;  lap  tenders;  card  brushers;  first  and  second 
breaker  hands;  finisher  pickers;  card  boys;  card  hands;  waste  hands; 
wastemen ;  card  clothiers ;  card  strippers ;  card  grinders ;  combers ;  lap- 
head  hands ;  doublers ;  drawing-frame  tenders ;  railway-head  tenders ;  slub- 
bers ;  speeders,  fly-frame  tenders ;  jack  tenders ;  rovers ;  spinners ;  bobbin 
boys;  yarn  pourers;  piecer  and  doffer;  back  boy;  band  boys;  doublers 
and  twisters ;  winders ;  yarn  untanglers ;  spool  boys,  white  spoolers ;  warp- 
ers; slasher  tenders;  size  makers;  reel  hands;  dye-house  hands  (with 
further  subdivisions) ;  beamers  and  splitters*  beam  carriers ;  warp  drawers ; 
harness  menders ;  harness  brushers ;  handers-in ;  twisters-in ;  loom  fixer ; 
pattern  makers ;  putters-up  of  samples ;  cloth  weavers ;  weavers  of  designs ; 
yarn  carriers ;  smash  piecers ;  spare  weavers ;  inspectors ;  trimmers.  The 
finishing  of  the  cloth  is  a  separate  industry.1 

This  form  of  the  divison  of  labor  may  also  exist  without  the 
use  of  complex  machinery,  as  in  the  slaughtering  and  meat- 
packing industry. 

"It  would  be  difficult  to  find  another  industry  where  division  of  labor  has 
been  so  ingeniously  and  microscopically  worked  out.  The  animal  has  been 
surveyed  and  laid  off  like  a  map ;  and  the  men  have  been  classified  in  over 
thirty  specialties  and  twenty  rates  of  pay  from  16  cents  to  50  cents  an  hour. 
The  50-cent  man  is  restricted  to  using  the  knife  on  the  most  delicate  parts  of 
the  hide  (floorman)  or  to  using  the  ax  in  splitting  the  backbone  (splitter) ; 
and  wherever  a  less  skilled  man  can  be  slipped  in  at  18  cents,  i8|  cents,  20 
cents,  21  cents,  22^  cents,  24  cents,  25  cents,  and  so  on,  a  place  is  made  for 
him  and  an  occupation  mapped  out.  In  working  on  the  hide  alone  there  are 
nine  positions  at  eight  different  rates  of  pay.  A  20-cent  man  pulls  off  the 
tail,  a  22^  cent  man  pounds  off  another  part  where  the  hide  separates  readily, 
and  the  knife  of  the  40-cent  man  cuts  a  different  texture  and  has  a  different 
'feel'  from  that  of  the  50-cent  man.  Skill  has  become  specialized  to  fit  the 
anatomy."  2 

1  From  the  Glossary  of  Occupations  in  the  volume  on  Employees  and  Wages. 
Twelfth  Census,  Special  Reports,  1903. 

2  Commons,  Trade  Unionism  and  Labor  Problems,  p.  224,  in  a  chapter  appearing 
originally  in  the  Quarterly  Journal  of  Economics,  vol.  xix,  p.  1. 


126  OUTLINES  OF  ECONOMICS 

Advantages  of  Division  of  Labor.  —  The  advantages  of  a 
division  of  labor  have  been  enumerated  as  follows :  (i)  A  gain 
of  time.  A  change  of  operations  costs  time.  Less  time  is 
also  consumed  in  learning  one's  business,  as  the  labor  of  each  is 
more  simple.  (2)  Greater  skill  is  acquired,  because  each  person 
confines  himself  to  one  operation.  (3)  Labor  is  used  more 
advantageously.  Some  parts  of  an  industrial  process  can  be 
performed  by  a  weak  person,  others  require  unusual  physical 
strength ;  some  require  extraordinary  intelligence,  some  can 
be  performed  by  a  man  of  very  ordinary  intellectual  powers. 
Special  capacities  are  best  utilized,  and  work  is  found  for  all, 
young  and  old,  weak  and  strong,  stupid  and  intelligent.  (4) 
Inventions  are  more  frequent,  because  the  industrial  processes 
are  so  divided  that  it  is  easy  to  see  just  where  an  improvement 
is  possible.  Besides  this,  when  a  person  is  exclusively  engaged 
in  one  simple  operation,  he  often  sees  how  the  appliances  he 
uses  could  be  improved.  Workmen  have  made  many  important 
inventions.  (5)  Capital  is  better  utilized.  Each  workman  uses 
one  set  of  tools,  or  one  part  of  a  set,  and  keeps  that  employed 
all  the  time.  When  each  workman  does  many  things,  he  has 
many  tools,  and  some  are  always  idle.  (6)  Finally,  where  the 
division  of  labor  results  in  the  simplification  of  operations,  it 
facilitates  the  substitution  of  machinery  with  mechanical 
power  in  place  of  direct  human  labor.  It  would,  for  example, 
probably  be  impracticable  to  make  a  machine  which  would 
directly  convert  leather  into  finished  shoes.  But  it  has  been 
found  a  relatively  simple  matter  to  devise  machines  which  will 
successfully  accomplish  each  of  the  successive  steps  in  shoe- 
making.  Such  a  subdivision  and  simplification  of  manufacturing 
processes  is  only  possible  when  they  are  conducted  on  a  large 
scale.  "  It  is  the  largeness  of  markets,  the  increased  demand 
for  great  numbers  of  things  of  the  same  kind,  and  in  some  cases 
of  things  made  with  great  accuracy,  that  leads  to  subdivision  of 
labor ;  the  chief  effect  of  the  improvement  of  machinery  is  to 
cheapen  and  make  more  accurate  the  work  which  would  any- 
how have  been  subdivided."  l 

1  Marshall,  Principles  of  Fxonomics,  6lh  cd.,  p.  255. 


PRODUCTION  127 

Effects  upon  the  Worker.  —  The  effect  of  the  introduction  of 
machinery  upon  wages  will  be  discussed  in  a  later  chapter,  but 
here  some  attention  must  be  given  to  the  effect  of  division  of 
labor  and  machinery  upon  the  life  of  the  worker.  It  is  fre- 
quently said  that  when  labor  is  rendered  simple  it  loses  both  its 
attractiveness  and  its  educational  value.  A  man  can  enjoy  his 
work  when  he  manufactures  a  whole  watch,  bearing  the  impress 
of  care  and  skill,  but  who  can  like  the  mere  routine  of  feeding 
material  into  some  machine?  A  workingman  becomes  a  mere 
cog  in  a  great  mechanism,  driven  at  a  certain  speed,  day  after 
day,  with  no  further  interest  in  the  result  of  his  labor  than  that 
it  is  the  source  of  his  daily  wage.  But  much  may  be  said  on  the 
other  side.  To  a  large  extent  the  heaviest  labor  is  done  with 
mechanical  appliances,  and  those  movements  which  are  very 
simple  and  regular  are  precisely  the  ones  which  are  likely  to  be 
taken  over  by  machinery,  leaving  to  human  beings  the  work 
which  requires  intelligence  and  skill. 

"Looked  at  broadly,  is  the  average  work  of  a  laborer  in  a  machine  industry 
less  dignified,  less  agreeable,  less  humanizing  than  it  was  before  the  industry 
reached  the  machine  stage?  From  the  nature  of  the  question,  it  is  danger- 
ous to  dogmatize,  because  neither  the  affirmative  nor  the  negative  is  capable 
of  being  demonstrated.  The  negative  view  seems  to  rest  mainly  upon  the 
assumption  that  it  is  more  dignified  to  be  occupied  with  a  great  many  purely 
mechanical  operations  than  with  a  very  few.  The  old-fashioned  shoe- 
maker, for  example,  was  largely  occupied  with  purely  mechanical  opera- 
tions, most  of  them  of  a  very  elementary  nature,  such  as  a  machine  can  do 
quite  as  well  as  a  man.  Each  of  these  operations  required  great  concen- 
tration of  attention,  leaving  him  very  little  opportunity  for  other  forms  of 
mental  activity.  He  was  the  slave  of  each  particular  task  as  truly  as  a 
modern  machine  worker  can  be  said  to  be  the  slave  of  his  single  task.  But 
the  old-fashioned  shoemaker  had  to  turn  from  one  kind  of  work  to  another. 
This  increased  the  difficulty,  and,  on  the  whole,  required  of  him  a  greater 
amount  of  concentration  than  is  now  required  of  the  operator  of  a  machine. 
The  latter,  who  has  but  one  routine  task  to  learn,  learns  it  easily,  and  can 
carry  it  out  without  very  intense  concentration  of  mind.  His  mind,  there- 
fore, would  seem  to  be  freer  than  that  of  the  old  hand  worker,  though  there 
was  more  variety  to  the  work  of  the  latter.  Whether  this  greater  variety 
is  to  his  advantage  or  disadvantage  would  be  difficult  to  determine  off- 
hand. It  looks  as  though  the  operator  of  a  machine  in  a  shoe  factory, 
being  relieved  of  the  necessity  of  acquiring  several  forms  of  specialized 


128  OUTLINES  OF   ECONOMICS 

manual  dexterity,  would  be  in  a  better  position  for  free  mental  activity  than 
the  old-fashioned  shoemaker."  1 

It  seems  that  those  who  declaim  against  factory  life  do  not 
always  distinguish  those  things  which  are  temporary  from 
things  which  are  inherent  in  the  system.  Long  hours,  insanitary 
conditions  of  work,  and  frequent  industrial  accidents  need  not 
•be  inevitable  accompaniments  of  the  use  of  machinery.  It  is 
the  efficiency  of  machine  methods  that  makes  leisure  possible 
for  the  workingmen,  and  when  they  learn  to  use  that  leisure 
sanely,  their  condition  will  be  far  in  advance  of  what  it  could 
be  under  more  primitive  methods  of  production. 

The  charge  is  also  brought  against  machine  production  that  it 
is  antagonistic  to  the  development  of  art.  Machine  production 
means  uniform  production.  It  is  possible  that  a  growth  in  the 
desire  for  what  is  beautiful  rather  than  cheap  will  limit  the  use 
of  machinery  in  some  directions  (e.g.  we  may  insist  upon  more 
hand  work  in  the  making  of  furniture),  but  an  extensive  use  of 
machinery  as  a  servant  of  art  will  always  be  necessary,  and 
that  in  two  ways :  (i)  For  an  appreciation  of  art  there  must  be 
leisure,  or  at  least  leisurely  work,  and  without  machine  methods 
this  is  not  possible  for  the  masses.  (2)  There  is  much  work  that 
is  preliminary  to  the  work  of  the  artist,  and  that  can  be  done  by 
machinery.  Will  a  building  be  less  artistic  because  much  of  the 
heavy  work  of  dressing  the  stone  is  done  by  machinery  ?  Taken 
as  a  whole,  however,  we  have  probably  been  too  much  inclined 
to  view  progress  as  something  that  causes  tons  per  capita  to 
increase  by  leaps  and  bounds,  rather  than  as  something  that 
improves  the  quality  of  our  enjoyments. 

Territorial  Division  of  Labor.  —  The  concentration  of  a  certain 
industry  in  a  particular  region  is  often  called  the  territorial 
division  of  labor,  or  the  localization  of  industry.  Illustrations 
are  seen  in  the  prominence  of  the  boot  and  shoe  industry  in 
Massachusetts ;  the  collar  and  cuff  manufacture  in  Troy,  New 
York ;  oyster  canning  in  Baltimore ;  the  manufacture  of  gloves 
in  Gloversville  and  Johnstown,  New  York ;  of  coke  in  the  Con- 

1  T.  N.  Carver,  "Machinery  and  the  Laborers,"  Quarterly  Journal  of  Economics, 
vol.  xxii,  p.  230. 


PRODUCTION 


129 


nellsville  district,  Pennsylvania;  or  brassware  in  Watcrbury, 
Connecticut ;  of  carpets  in  Philadelphia ;  of  jewelry  in  Provi- 
dence, Rhode  Island,  and  Attleboro  and  North  Attleboro,  Massa- 
chusetts ;  slaughtering  and  meat  packing  in  Chicago ;  the  man- 
ufacture of  plated  and  britannia  ware  in  Meriden,  Connecticut ; 
and  of  silk  in  Paterson,  New  Jersey.  The  following  causes 
of  localization  have  been  mentioned :  (1)  proximity  to  raw 
material,  (2)  accessibility  of  markets,  (3)  presence  of  water 
power,  (4)  favorable  climate,  (5)  availability  of  labor,  (6) 
availability  of  capital,  and  (7)  the  momentum  of  an  early  start. 
The  explanation  of  how  these  causes  have  operated  in  particular 
instances  is  left  as  an  exercise  for  the  student.1 

Productive  Organization  of  the  American  People.  —  Accord- 
ing to  the  Census  of  1910  about  two  fifths  of  the  total  population 
and  about  one  half  of  the  population  ten  years  of  age  and  over 
are  engaged  in  gainful  occupations.  In  the  following  table 
the  extent  to  which  persons  in  each  age  group  are  gainfully  em- 
ployed is  shown  for  each  sex : 

TABLE  I 

Number  and  Percentage  Engaged  in  Gainful  Occupations  for  Spec- 
ified Age  Groups  of  Males  and  Females:   19102 


Males  of  Specified  Age 

Females  of  Specified  Age 

Age 

Number 

Engaged  in  Gainful 
Occupations 

Number 

Engaged  in  Gain- 
ful Occupations 

Number 

Per 

Cent 

Number 

Per 
Cent 

10-13  years 
14-15  years 
16-20  years 
21-44  years  3 
45  years  and 
over      .     . 

3,665,779 

1,798,449 

4,564,179 

17,848,843 

9,149,308 

609,030 

744,109 

3,615,623 

17,262,209 

7,860,593 

16.6 
41.4 
79.2 
96.7 

85-9 

3,593,239 

1,770,898 

4,632,821 

16,331,449 

8,224,305 

286,946 

350,140 

1,847,600 

4,302,969 

1,288,117 

8.0 
19.8 

39-9 

26.3 

15-7 

10  years  and 
over     .     . 

37,027,559 

30,091,564 

81.3 

34,552,712 

8,075,772 

234 

1  Consult  Hall,  "The  Localization  of  Industry,"  Census  Bulletin  No.  244  (also 
found  in  Twelfth  Census,  Manufactures,  Part  i,  p.  cxc),  and  Ross,  "The  Locali- 
zation of  Industry,"  Quarterly  Journal  of  Economics,  vol.  x,  p.  247.  Also  the 
Federal  Census  of  Manufactures  for  1005,  vol.  i,  Chap.  xii. 

'Thirteenth  Census,  vol.  iv,  p.  69.  3  Includes  persons  of  unknown  age. 


13° 


OUTLINES   OF  ECONOMICS 


The  following  table  shows  the  distribution  of  the  gainful 
workers  among  the  five  main  classes  of  occupations.  The  most 
striking  facts  are  the  decline  in  the  relative  importance  of  agri- 
cultural pursuits  and  the  increase  in  the  relative  importance  of 
trade  and  transportation. 

TABLE  II 

Distribution  by  Main  Classes  of  Persons  Engaged  in  Gainful  Occu- 
pations 


Class  of  Occupation 

1910 

1900 

1890 

1880 

Agricultural  pursuits 

Domestic  and  personal  service        .     . 
Trade  and  transportation       .... 
Manufacturing  and  mechanical  pursuits 

32-9 

4.8 

14.0 

19.9 

28.3 

35-7 
4-3 
19.2 
16.4 
24.4 

39-2 
4.0 
18.1 
14.3 
24.4 

44-3 
3-5 
19.6 
10.8 
21.8 

100.0 

100.0 

100.0 

100.0 

The  broad  territorial  division  of  labor  is  seen  when  these  per- 
centages are  given  separately  for  groups  of  states : 

TABLE   III 

Percentage  Distribution  of  Persons  10  Years  of  Age  and  Over  En- 
gaged in  Gainful  Occupations,  by  Geographic  Divisions:    19101 


0 

§ 

w  ., 

§4 

D 

Division 

w 
g 

5 

O 

a 

< 

0 

i 

< 

1 

< 

•< 

1 

i 

< 

as 
H 

w 

1 

a  s  a 

<«  || 

Ui 

Z 

O 

E/3 
(A 

H 

K 
0 
M 

£ 

5  a 

t  *  s 

2 ,9 

0  w 

►J  O 
<  S 
a< 

OS    i. 

Id 

O 

New  England      .     .     . 

10.4 

0.3 

49.1 

6,S 

10.6 

1.7 

4-8 

I0.7 

5-9 

Middle  Atlantic       .     . 

10.0 

4.2 

40.6 

8.0 

12.0 

1.4 

4.9 

11.8 

7-i 

East  North  Central 

2^.6 

2.6 

33-2 

7.6 

10.6 

I.I 

4-8 

9.2 

5-3 

West  North  Central     . 

41.2 

1.8 

20.0 

7.8 

10.4 

1. 1 

S-2 

8.s 

3-9 

South  Atlantic    .     .     . 

5i-4 

1.8 

18.6 

S.o 

6.1 

1.0 

3-o 

10.5 

2.6 

East  South  Central 

63.2 

1.9 

12.4 

4.0 

5-3 

0.6 

2.6 

8.4 

i-7 

West  South  Central     . 

60.1 

0.7 

12.6 

S-2 

7.0 

0.8 

3-3 

8.1 

2.1 

Mountain       .     .     .     . 

32-4 

9.4 

19-5 

10.3 

8.7 

1.7 

5-2 

9.1 

3-6 

Pacific 

22.6 

2.4 

27.2 

10.3 

12.6 

2.0 

6.0 

"•3 

S-S 

United  States      .     .     . 

33-2 

2.5 

27.9 

6.9 

9-5 

1.2 

4.4 

9.9 

4.6 

1  Thirteenth  Census,  vol.  iv,  p.  45. 


PRODUCTION 


QUESTIONS 


J3I 


1.  Is  the  employee  in  a  planing  mill  in  a  worse  position  than  the  old-time 
carpenter  who  has  to  do  his  planing  by  hand? 

2.  Is  the  keeper  of  a  gambling  establishment  a  producer  of  wealth? 

3.  Is  an  insurance  agent  a  producer  of  wealth? 

4.  What  would  happen  if  there  should  be  too  much  saving? 

5.  Why  is  Massachusetts  the  center  of  the  boot  and  shoe  industry? 

6.  Write  a  survey  of  national  resources  and  production  in  the  United 
States  from  data  in  the  Statistical  Abstract  of  the  United  States. 

REFERENCES 

Ely,  R.  T.     Property  and  Contract,  Vol.  ii,  Appendix  iii. 

Fisher,  Irving.     The  Nature  of  Capital  and  Income,  Chaps,  v  and  vi. 

Hobson,  J.  A.     The  Social  Problem,  Book  ii,  Chap,  ii ;  and  Work  and  Wealth, 

Chaps,  iv-viii. 
Marshall,  Alfred.     Principles  of  Economics,  6th  ed.,  Book  iv. 
National  Conservation  Commission,  Report  (1909). 
Thirteenth  Census,  Reports. 
Statistical  A  bstract  of  the  United  Stales  (annual) . 
Taussig,  F.  W.     Principles  of  Economics,  Vol.  i,  Chaps,  ii-v. 
Van  Hise,  C.  R.     Conservation  of  Natural  Resources  in  the  United  States. 
Veblen,  Thorsteln.     The  Theory  of  Business  Enterprise,  Chaps,  ii  and  iii. 


CHAPTER  IX 
CONSUMPTION 

Consumption  Denned.  —  Consumption  means,  in  economics, 
the  use  of  goods  in  the  satisfaction  of  human  wants,  directly  or 
indirectly.  It  is  the  chief  incentive  to  economic  activity,  but 
it  is  not  the  sole  incentive,  for  such  activity  is  to  a  certain  extent 
an  end  in  itself.  Nevertheless,  in  economic  society  as  it  is 
organized  to-day  we  are  justified  in  looking  upon  the  consumption 
of  material  goods  in  the  satisfaction  of  human  wants  as  the 
essential  motive  and  purpose  of  the  production  of  such  goods. 
Wants  are  so  far  from  satisfied  that  most  men  must  work,  not 
because  of  the  pleasure  they  may  derive  from  the  exercise  of 
their  capacities,  or  to  utilize  fully  their  natural  energies  of 
brain  or  muscle,  but  because  they  need  or  crave  the  goods 
which  their  wages  will  buy.  Regarded  as  an  incentive  to 
economic  activity,  consumption  should,  of  course,  be  defined 
so  as  to  include  the  use  made  of  direct  personal  services  as  well 
as  of  material  goods. 

The  philosophy  of  the  consumption  of  wealth  falls  only  partly 
within  the  domain  of  economics,  for  the  use  of  wealth  is  a  large 
part  of  the  problem  of  life.  Passing  judgment  on  the  rational 
standards  according  to  which  the  true  importance  of  different 
wants  should  be  measured  does  not  directly  concern  us  in  the 
study  of  economics. 

Productive  and  Final  Consumption.  —  When  used  without 
qualification,  the  word  "  consumption  "  in  economics  is  com- 
monly taken  to  refer  to  the  use  of  goods  or  services  to  satisfy 
wants  directly.  But  some  goods,  such  as  machines  and  raw 
materials,  are  used  up  in  the  production  of  other  goods.  This 
we  may  call  productive  consumption,  while  that  consumption 
which  results  directly  in  the  satisfaction  of  wants  is  final  con- 
sumption.    It  is  now  less  necessary  than  it  was  in  the  days  of 

132 


CONSUMPTION  133 

Carlyle  and  Ruskin  to  insist  that  food  consumed  by  laborers 
is  not  productive  consumption.  It  is  true  that  some  analogy 
lies  between  the  consumption  of  fuel  by  an  engine  and  the  con- 
sumption of  food  by  a  worker,  but  there  is  the  very  important 
difference,  that  the  engine  is  specifically  adapted  to  render 
economic  service  and  cannot  be  conceived  to  derive  any  benefit 
whatever  from  its  consumption  of  fuel,  while  in  the  case  of  the 
worker  the  consumption  of  food  is  determined  with  primary 
reference  to  his  natural  appetites  and  individual  welfare.  Man 
is  our  final  term. 

Human  Wants.  —  In  the  study  of  human  wants  as  a  starting 
point  in  economic  theory,  two  facts  stand  out  prominently :  the 
expansion  in  the  number  and  variety  of  wants,  and  the  satiability 
of  any  particular  one  of  them.  As  man  has  progressed  from 
savagery  to  civilization,  the  variety  of  things  he  desires  and  even 
considers  necessary  to  his  existence  has  expanded  enormously. 
His  interests  become  more  varied,  his  capacity  to  enjoy  becomes 
larger,  and  he  lives  a  fuller  and  more  complex  existence.  There 
are  indeed  those  who  would  have  us  "  return  to  nature  "  and 
live  a  simple  life,  but  taking  the  world  as  it  is,  the  expansion  of 
human  desires  with  passing  time  appears  to  be  without  limit. 

But  when  we  turn  to  consider  some  specific  want  by  itself,  as 
it  is  at  any  particular  time,  the  matter  is  different.  Our  nerves 
weary  of  a  repeated  stimulus,  and  any  attempt  to  continue 
indefinitely  the  enjoyment  of  some  sensation  results  in  satiation, 
A  phonograph  record  grows  stale  after  a  number  of  repetitions. 
An  apple  has  differing  degrees  of  utility  for  any  one  of  us,  vary- 
ing from  the  highest  degree,  if  we  are  on  the  point  of  starvation, 
to  disgust,  if  a  considerable  number  have  just  been  consumed. 

Law  of  Diminishing  Utility.  —  The  fact  that  the  intensity  oj 
our  desire  for  additional  units  of  a  commodity  decreases  as  we 
acquire  successive  units  is  of  fundamental  importance  in  economic  ; 
science.  And  this  "  law  of  diminishing  utility,"  as  it  is  called, 
rests  upon  a  broader  basis  of  human  experience  than  the  mere 
satiability  of  the  appetite  for  a  particular  kind  of  food,  or  the 
growing  weariness  of  the  nerves  under  the  repetition  of  a  partic- 
ular stimulus.     The  truth  is  that  most  commodities   serve  a 


134  OUTLINES  OF  ECONOMICS 

multitude  of  different  needs  and  different  purposes,  and  that 
these  needs  and  purposes  vary  greatly  in  their  importance.  It 
is  better  to  have  two  suits  of  clothes  than  to  have  one,  but  it  is 
by  no  means  twice  as  important.  And  a  third,  or  a  fourth, 
or  a  tenth  suit,  are,  in  order,  of  rapidly  decreasing  importance. 
How  large  shall  my  building  lot  be?  How  many  rooms  shall 
I  have  in  my  house?  How  much  electric  current  shall  I  use 
for  lighting  purposes?  How  many  motor  cars  shall  I  own? 
How  many  servants  shall  I  employ?  Questions  such  as  these 
at  once  suggest  the  way  in  which  a  certain  minimum  amount  of 
a  given  commodity  or  of  a  given  service  may  be  deemed  ex- 
ceedingly important  for  our  purposes,  and  how  a  diminishing 
importance  is  attached  to  successive  additional  portions  or 
increments.  So  far  as  any  one  commodity  is  concerned  it  is 
in  general  less  important  to  have  more  than  to  have  some. 

To  guard  against  possible  misunderstanding  a  word  of  caution 
is  necessary  at  this  point.  With  passing  time  the  use  of  a  partic- 
ular commodity  often  cultivates  a  taste  for  it,  so  that  an  increased 
supply  is  more  urgently  desired  than  were  the  earlier  increments. 
Thus  familiarity  with  good  books  or  good  pictures  or  good 
music  may  increase  the  pleasure  that  we  find  in  such  things,  and 
so  may  intensify  our  desire  to  have  more.  And  bad  habits, 
like  good  ones,  are  prone  to  "  grow  on  us."  Such,  for  example, 
is  the  case  in  the  use  of  habit-forming  drugs.  But  these  facts 
do  not  contradict  the  law  of  diminishing  utility.  For  that  law 
relates  only  to  the  consumer  as  he  is  at  any  given  time,  with 
whatever  possessions,  habits,  desires,  and  aversions  are  his  at 
that  time.  Men  change  and  their  wants  change,  and  the 
character  of  a  man's  consumption  is,  of  course,  a  very  important 
factor  in  changing  his  wants.  But  just  now  we  are  considering 
men  as  potential  buyers  of  more  goods  or  sellers  of  surplus  goods 
in  a  given  market  at  a  given  time,  and  for  men  so  considered 
the  law  of  diminishing  utility  expresses  a  fundamental  truth  of 
very  great  significance. 

A  thoughtful  reader  may  object  that  in  view  of  the  considerations  urged 
in  the  preceding  paragraph  such  illustrations  as  that  of  the  satiety  resulting 
from  eating  a  number  of  apples  are  not  exactly  to  the  point,  for  when  the 


CONSUMPTION  135 

hungry  eater  of  apples  becomes  a  satiated  eater  of  apples,  he  is,  in  that 
respect,  a  "changed  person."  It  is  true  that  some  expositions  of  the  prin- 
ciple of  diminishing  utility  attach  altogether  too  much  importance  to  what 
have  been  called  "dinner- table  illustrations."  But  the  real  point  in  the 
matter  is  that  the  satiation  of  the  appetite  is  a  familiar  fact  of  experience, 
which  has  an  important  bearing  upon  the  character  of  our  wants  as  they 
manifest  themselves  at  any  one  time.  If  I  am  hungry,  but  have  six  apples, 
I  will  give  less  for  another  apple  than  if  I  had  only  one. 

Marginal  Utility.  —  It  must  be  evident,  therefore,  that  to 
say  that  a  certain  thing  possesses  utility  is  very  indefinite.  That 
merely  tells  us  that  it  is  capable  of  satisfying  some  want,  per- 
haps important,  perhaps  unimportant.  And,  furthermore, 
one  may  use  some  units  of  a  commodity  in  the  satisfaction  of 
very  important  wants,  and  other  units  of  the  same  commodity 
in  the  satisfaction  of  relatively  unimportant  wants.  This 
amounts  to  saying  that  for  any  one  person  different  units  of 
the  same  commodity  may  possess  very  different  degrees  of 
utility.  The  utility  of  the  final  or  marginal  unit  of  a  person's 
stock  of  a  given  commodity  is  called  the  marginal  utility  of  that 
commodity  to  that  person.  If,  for  example,  a  boy  has  six  apples, 
the  marginal  utility  of  apples  to  him  is  simply  the  utility  (or 
want-satisfying  capacity)  of  the  sixth  apple.  This  does  not 
mean  the  utility  of  any  particular  apple,  but  does  mean  (if  the 
apples  are  all  alike)  the  utility  dependent  on  the  possession  of 
any  one  apple  of  his  stock  of  six.  This  will  be  less  than  if  he 
had  fewer  apples,  and  more  than  if  he  had  a  larger  number. 
So  with  a  householder  who  has  a  stock  of  ten  tons  of  coal  for 
his  winter's  supply.  The  tenth  ton  (any  one  ton  of  the  ten) 
is  the  marginal  ton ;  and  the  utility  it  adds  is  the  marginal  utility 
of  coal  to  the  householder.  Marginal  utility  thus  depends  upon 
the  intensity  of  the  want  dependent  for  its  satisfaction  upon  the 
possession  of  one  unit  of  a  commodity.  The  larger  one's  supply 
of  a  commodity,  the  smaller  in  general  will  be  the  importance 
one  attaches  to  the  possession  of  any  one  unit  of  the  supply. 

Some  writers  prefer  to  define  marginal  utility  as  the  utility  of  an  addi- 
tional unit  of  a  commodity  rather  than  as  the  utility  of  the  last  unit  of  one's 
present  stock.  In  some  applications  of  economic  analysis  it  is  convenient 
to  think  of  the  successive  units  or  increments  in  the  supply  of  a  commodity 


136 


OUTLINES  OF   ECONOMICS 


as  indefinitely  small.  In  this  case  the  difference  beween  the  "last  unit" 
and  an  "additional"  unit  becomes  negligible.  But  for  many  purposes  it  is 
more  convenient  to  think  of  the  size  of  our  successive  increments  as  being 
that  of  the  ordinary  units  in  which  goods  are  customarily  bought  and 
sold.  In  such  cases  whether  the  "last  unit"  or  the  "additional  unit"  should 
be  considered  the  marginal  unit  depends  upon  whether  we  think  of  the 
individual  concerned  as  a  possible  seller  or  a  possible  buyer.  If  the  boy 
with  the  apples  is  weighing  the  desirability  of  having  yet  another  apple 
against  that  of  some  peanuts  he  would  have  to  part  with  in  exchange  for 
it,  the  marginal  utility  of  apples  to  him  may  properly  be  said  to  be  the 
utility  of  the  additional  apple,  for  this  is  the  basis  of  its  subjective  impor- 
tance for  the  purpose  in  hand.  But  if  he  is  contemplating  the  exchange  of 
an  apple  for  additional  peanuts  the  marginal  utility  of  apples  to  him  depends 
upon  the  importance  of  the  sixth  apple.  It  is  always  accurate  to  identify 
marginal  utility  with  the  utility  of  the  last  unit  of  a  stock,  if  we  remember 
that  in  some  cases  it  is  the  last  unit  of  an  existing  stock  and  in  other  cases 
the  last  unit  of  a  (possibly)  increased  stock. 


Marginal  Utility  Illustrated.  —  A  clearer  notion  of  marginal 
utility  may  be  given  with  the  help  of  Figure  1,  following.      We 

take  for  our  illustration 
the  consumption  of  water, 
which  has  numerous  uses 
of  various  degrees  of  im- 
portance. We  have  marked 
off  different  portions  of  the 
base  line  representing  quan- 
tities of  water  available  for 
man's  use.  The  first  quan- 
tity, ab,  is  just  enough  for 
drinking  purposes.  Sup- 
pose this  is  all  the  water 
to  be  had.  There  will  be  no  question  of  sprinkling  lawns  or 
even  of  bathing  under  such  circumstances.  What  will  be  the 
utility  of  water?  Evidently  the  extent  of  the  service  which 
it  renders  us,  and  as  this  is  the  preservation  of  our  life  we  cannot 
estimate  it.  We  will  indicate  it  by  the  area  above  the  line  ab 
which  runs  upward  indefinitely  as  the  curved  line  fails  to  close 
in.  What  will  be  the  importance  of  another  portion  of  water 
at  this  point  of  supply?     As  this  additional  portion  which  we 


Fig.  i 


CONSUMPTIVE  137 

desire  is  not  needed  for  drinking  but  for  a  less  important  pur- 
pose, the  marginal  utility  of  the  water  will  now  depend  upon 
the  urgency  of  this  less-important  want.  Now  suppose  we 
have  three  portions  of  water,  represented  by  the  lines  ab, 
be,  and  cd.  We  now  have  enough  for  all  our  wants,  down 
to  sprinkling  the  lawn  and  the  street.  We  are  willing  to 
pay  something  for  more  water  for  this  purpose,  but  how 
much  ?  As  much  as  when  we  had  only  water  enough  to  drink  ? 
By  no  means.  The  next  want  on  our  list  is  comparatively 
unimportant,  and  of  course  we  appraise  an  increased  supply 
accordingly.  With  two  or  three  more  portions  of  water  all 
our  wants  are  satisfied,  and  the  marginal  utility  of  water 
will  have  become  zero.  As  the  amount  of  water  is  increased, 
the  utility  falls  according  to  the  curved  line  hi,  till  finally  it 
touches  the  base  line,  where  the  marginal  utility  of  the  water 
vanishes. 

Subjective  Value.  —  As  we  proceed  in  our  study  we  shall  see 
that  the  most  important  problem  of  economics  is  that  of  as- 
certaining the  laws  which  determine  the  prices  of  different  goods 
and  services.  To  some  goods  and  some  services  more  impor- 
tance is  attached  than  to  others,  and  larger  quantities  of  the  less 
important  goods  and  services  can  be  obtained  in  exchange  for 
smaller  quantities  of  the  more  important  goods  and  services. 
This  is  a  matter  of  prime  significance,  since  it  determines  the 
way  in  which  the  different  persons  who  contribute  goods  and 
services  to  the  aggregate  wealth-product  of  the  community  will 
be  able  to  secure  shares  in  it. 

We  are  not  yet  ready  to  attack  the  general  problems  of  value, 
but  we  can  take  an  important  step  forward  at  this  point  by 
grasping  the  meaning  of  subjective  value. 

The  subjective  value  of  a  good  is  not,  of  course,  a  definitely 
measurable  objective  quality  of  the  good,  like  weight  or  exten- 
sion. It  is,  as  the  word  "  subjective  "  implies,  purely  psycholog- 
ical, and  may  be  different  for  different  persons.  It  is,  moreover, 
purely  relative.  The  subjective  valuation  of  things  always 
implies  the  choosing  of  some  things  rather  than  others.  In 
other  words,  it  involves  a  determination  of  their  comparative 


138  OUTLINES  OF  ECONOMICS 

importance  for  one's  own  purposes.  More  formally  stated,  the 
subjective  value  of  a  good  to  any  person  is  that  person's  estimate  oj 
the  importance  of  possessing  that  good  as  compared  with  the  im- 
portance of  possessing  other  goods. 

But  we  do  not  value  things  in  the  abstract,  or  in  indefinite 
quantities.  In  buying  coal  or  sugar  or  oranges  we  do  not  have 
to  confront  the  alternatives  of  either  doing  entirely  without  such 
commodities  or  acquiring  an  indefinitely  large  supply.  If  we 
decide  to  buy  at  all,  we  may  buy  as  little  as  we  please.  Our 
choices,  in  practice,  resolve  themselves  into  questions  of  more 
or  less.  Even  in  the  case  of  an  indivisible  good  —  an  auto- 
mobile, for  example  —  one  may  choose  between  having  more  or 
less  of  certain  desirable  qualities,  such  as  size,  or  power,  or 
attractive  finish.  And  it  is  evident  that  whether  the  importance 
that  we  attach  to  the  possession  of  an  additional  unit  of  a  cer- 
tain good  is  greater  or  less  than  the  importance  that  we  attach 
to  an  additional  unit  of  some  other  good  will  depend,  very 
largely,  upon  the  extent  to  which  our  wants  for  each  of  the 
goods  in  question  are  satisfied  without  the  possession  of  the 
additional  unit.  Put  in  other  words,  the  question  is :  Which 
good  has  the  higher  marginal  utility? 

Subjective  value,  then,  involves  a  balancing  or  comparison 
of  marginal  utilities.  In  fact,  we  may  say  that  the  subjective 
value  of  a  good  is  the  expression  of  its  relative  marginal  utility.  In 
this  statement  the  word  relative  is  used  in  order  to  emphasize 
the  element  of  comparison  or  choice. 

The  Subjective  Value  of  a  Stock  of  Goods.  —  It  should  be 
carefully  noted  that  marginal  utility  tells  us  nothing  about  the 
total  subjective  value  of  one's  whole  stock  of  the  commodity. 
It  refers  solely  to  the  present  value  of  an  additional  unit,  or 
the  sacrifice  that  would  be  occasioned  by  the  loss  of  a  unit.  We 
cannot  get  the  total  subjective  value  of  a  stock  of  goods  by  mul- 
tiplying the  marginal  utility  by  the  number  of  units,  even  though 
they  be  all  alike.  The  very  term  "  marginal  "  tells  us  that  the 
conception  implies  successive  additions,  and  the  present  im- 
portance of  one  unit  tells  us  nothing  definite  about  the  im- 
portance of  the  other  units.     If  we  wish  to  ascertain  the  total 


CONSUMPTION 


139 


subjective  value  of  a  stock  of  a  commodity,  we  have  simply  to 
treat  it  as  one  large  unit,  and  ask  what  would  be  lost  if  it  were 
taken  away.  By  this  test  all  air  would  be  found  to  have  an 
immeasurable  utility,  at  the  same  time  that  the  subjective  value 
of  an  additional  cubic  foot  would  be  nothing.  Thus  it  will  be 
seen  that  the  cause  of  subjective  value  is  utility  under  a  condi- 
tion of  scarcity ;  that  is,  such  a  limitation  of  the  supply  that  not 
all  wants  can  be  satisfied. 

The  Economic  Order  of  Consumption.  —  What  has  been  said 
regarding  the  way  in  which  our  individual  estimates  of  the  im- 
portance of  a  commodity  are  determined  will  help  to  explain 
how  we  make  our  choices  in  attempting  to  obtain  the  largest 


la 

lb 

1c 

Id 

le 

2  n 

2  b 

2  c 

2d 

2e 

Fig. 


Fig.  3 


amount  of  satisfaction  with  the  income  at  our  disposal.  Evi- 
dently we  must  spend  each  succeeding  dollar  for  purchasing  that 
commodity  of  which  a  dollar's  worth  will  give  the  greatest 
satisfaction.  Let  Figures  2  and  3  show  the  declining  impor- 
tance of  two  commodities  which  an  individual  is  consuming,  and 
suppose  that  each  unit  of  each  commodity  costs  one  dollar.  If 
the  individual  has  ten  dollars  to  spend  upon  these  two  commodi- 
ties, his  order  of  consumption  will  be  as  follows :  he  would  begin 
with  2a,  but  another  unit  of  commodity  2  would  give  him  less 
satisfaction  than  a  unit  of  commodity  1.  Hence,  his  consump- 
tion will  continue  as  follows  : 

1a,  2b,  2c,  ib,  ic,  id,  2d;  2e,  le. 


140 


OUTLINES   OF   ECONOMICS 


In  this  illustration  it  was  assumed  that  a  unit  of  each  com- 
modity had  the  same  cost.  In  this  case,  the  unit  consumed  is 
always  the  one  that  has  the  largest  utility.  But  where  the 
cost  of  the  units  is  different,  cost  must  be  considered  also, 
and  we  commonly  do  so  by  asking  ourselves  whether  the  thing 
we  are  buying  is  worth  as  much  as  other  things  which  could  be 
obtained  with  the  same  expenditure.  Thus  we  are  constantly 
abstaining  from  the  further  consumption  of  one  thing,  not 
because  our  wants  for  it  are  fully  satisfied,  but  because  some- 
thing else  of  equal  cost  appears  at  that  moment  to  be  more 
important. 

Future  Wants.  —  Not  all  of  the  goods  for  which  we  strive  are 
wanted  for  present  consumption.     We  recognize  that  we  shall 


N. 


la 

lb 

lc 

Id 

le 

A*_L  iP- 1  --c—'l  ?£  j  _£  £  J 

Fig.  4  Fig.  5 

have  needs  next  month  or  next  year,  and  we  attempt  to  make 
some  preparation  for  them.  These  future  needs,  it  is  true, 
usually  appeal  to  us  less  vividly  than  if  they  were  present,  but 
we  attach  a  present  importance  to  them  and  grade  them,  and 
they  enter  into  our  calculations  when  we  spend  money,  modifying 
the  order  of  our  consumption.  This  will  be  seen  from  Figures 
4  and  5.  Let  us  suppose  that  in  Figure  4,  a,  b,  c,  d,  e  represent 
the  diminishing  importance  of  successive  units  of  a  commodity 
for  present  consumption,  and  that  Figure  5  shows  the  present 
importance  attached  to  the  future  consumption  of  similar  units. 
Then  an  individual  would  consume  1a,  i.e.  in  the  present. 
But  a  second  unit  for  present  use  would  rank  lower  in  present 
esteem  than  a  unit  saved  for  future  use.    The  unit  2a  would 


CONSUMPTION 


141 


then  be  saved,  and  then  the  order  would  be  as  follows:  ib, 
2b,  jc,  etc.  Thus  this  individual  has  saved  two  out  of  five 
units,  i.e.  2a  and  2b,  with  the  same  sort  of  mental  calcula- 
tion as  he  would  use  in  deciding  to  spend  a  nickel  for  a 
peach  rather  than  for  a  pear.  But  if  some  one  should  ask  him 
to  spend  his  fifth  dollar  for  2c  instead  of  for  ic,  he  would  require 
some  extra  inducement  to  induce  him  to  postpone  at  ruling 
prices.  It  thus  appears  that  a  certain  amount  of  saving  is  done 
without  payment,  but  if  saving  is  to  be  carried  beyond  a  certain 
point,  it  must  be  given  some  special  premium  or  compensation. 
This,  as  we  shall  see  later,  has  a  very  important  bearing  upon 
the  problem  of  interest. 

The  Margin  of  Consumption.  —  Either  by  a  conscious  balancing  against 
each  other  of  the  pleasures  to  be  obtained  from  two  or  more  possible  pur- 
chases, or  oftener,  by  simply  buying  the  things  which  we  want  more  than  we 
want  other  things,  we  tend  to  keep  our  unsatisfied  wants  in  a  state  of  ap- 
proximately equal  intensity.  We  apportion  our  expenditures  so  that  our 
money  will  "go  as  far  as  possible";  that  is,  so  that  it  will  provide  those 
things  that  have  the  strongest  present  appeal  to  us.  Every  person  thus  has  a 
margin  of  consumption,  which  is  measured  by  the  utility  obtained  in  return 
for  the  final  or  marginal  dollar  expended  for  any  one  of  the  things  that  he 
consumes.  If  he  unwisely  expends  too  much  for  any  one  thing,  his  more 
important  unsatisfied  wants  for  other  things  press  upon  him  urgently,  and 
he  is  apt  to  try  to  restore  the  balance  or  equilibrium  in  his  expenditures, 
or,  in  other  words,  to  bring  his  margin  of  consumption  into  alignment. 

An  individual's  margin  of  consumption  depends  primarily  on  his  income, 
but  also  on  his  tastes  and  habits,  his  disposition  to  save,  and  the  relative 
emphasis  which  he  places  upon  his  present  and  his  future  wants.  Then, 
too,  one's  desires  are  constantly  changing  under  the  influence  of  whim, 
fashion,  satiety,  sellers'  advertising,  education,  travel,  reading,  and  new 
experiences  of  all  kinds.  Expenditures  of  all  kinds  are  thus  called  into 
being  by  the  necessity  of  maintaining  the  level  of  the  margin  of  consumption. 

The  margin  of  consumption  is  different  for  different  persons.  This  is 
partly  a  matter  of  differences  in  individual  tastes  and  purposes,  but  it  is 
more  largely  a  matter  of  differences  in  incomes.  The  larger  one's  income, 
the  lower,  of  course,  is  one's  margin  of  consumption,  in  the  sense  that  one 
is  able  to  acquire  goods  in  larger  quantities  and  thus  to  satisfy  wants  of 
less  urgency.  And,  of  course,  a  larger  variety  of  commodities  can  be  con- 
sumed, so  that  as  one's  income  increases,  one's  margin  of  consumption  is 
normally  extended  downward  and  outward,  including  more  things,  but  things 
of  less  importance. 


142  OUTLINES  OF  ECONOMICS 

Consumption  and  Saving.  —  It  is  difficult  to  say  just  where 
consumption  should  stop  and  saving  begin,  to  secure  the  best 
results  for  society  as  a  whole,  but  the  principle  is  clear.  So 
much,  and  only  so  much,  should  be  saved  as  will  conduce  to  a 
maximum  total  service  over  long  periods  of  time.  The  present 
generation  might  deny  itself  everything  except  the  barest  neces- 
sities, and  labor  to  increase  the  productive  equipment  to  be  used 
in  the  future ;  but  the  next  generation  could  not  pursue  the  same 
policy,  for  some  one  must  consume  the  products  of  the  factories 
built  today,  otherwise  the  building  of  them  is  wasted  effort. 

Alleged  Present  Consumption  of  Future  Products.  —  We 
often  hear  of  consumption  in  advance  of  production.  It  is 
said  people  live  on  the  future.  It  is  frequently  argued  that 
during  the  American  Civil  War  we  were  consuming  faster  than 
we  were  producing.  It  is  alleged  that  the  government  borrow- 
ings at  that  time  represented  the  consumption  of  future  earnings. 
But  it  must  be  apparent  that  it  is  impossible  to  consume  faster 
than  we  produce  unless  we  consume  past  savings  by  not  replacing 
worn-out  equipment,  or  by  failing  to  maintain  the  customary 
stocks  of  goods,  or  unless  we  borrow  from  other  nations.  We 
cannot  eat  today  the  wheat  or  potatoes  of  tomorrow,  nor  can 
we  wear  coats  before  they  are  made.  What  is  alleged  can  never 
be  true  except  of  the  individual  consumer  within  the  nation, 
or  of  the  nation  as  a  whole  when  the  capital  or  other  wealth 
of  the  country  is  diminishing,  or  when  its  foreign  debt  is  in- 
creasing. What  really  happened  at  the  time  of  the  Civil  War 
was  this:  we  as  a  nation  became  indebted  to  some  extent 
to  foreigners,  and  within  the  nation  some  of  us  gained  while 
the  rest  were  losing.  Government  borrowings  do  not  represent 
a  present  consumption  of  future  wealth,  but  a  special  present 
use  of  purchasing  power  for  which  a  government  agrees  to  re- 
munerate its  owners  in  the  future.  If  war  can  be  carried  on 
with  the  aid  of  borrowings,  it  can,  —  leaving  out  of  considera- 
tion what  foreigners  send,  —  with  a  sufficiently  perfect  taxing 
machinery,  conceivably  always  and  practically  sometimes,  be 
carried  on  without  borrowing.  It  is  only  a  question  of  how  tc 
get  hold  of  the  means  of  producing  powder  and  bullets  and  the 


CONSUMPTION  143 

necessaries  of  life.  War  was  formerly  carried  on  without  bond 
issues ;  they  are  a  comparatively  recent  contrivance.  Consump- 
tion can  never  anticipate  future  production  for  the  nation  as  a 
whole  taken  by  itself ;   it  can  only  anticipate  future  ownership. 

Luxury.  —  Luxury  is  the  name  of  a  vague  something  which 
society  has  always  viewed  with  a  sense  of  mingled  tolerance 
and  condemnation.  What  is  its  meaning?  In  the  first  place, 
it  is  clear  that  people  ordinarily  consider  as  luxuries  many  things 
in  themselves  innocent  and  desirable,  as  handsome  dresses, 
jewels,  pictures,  etc.  No  one  but  an  ascetic  will  condemn  as 
wrong  in  themselves  things  that  appeal  to  taste  and  finer  appre- 
ciations, and  yet  we  feel  that  the  use  of  such  things  is  not  always 
justifiable.  Second,  the  popular  idea  of  luxury  recognizes  a 
difference  in  persons.  We  cannot  help  condemning  in  one 
person  what  we  approve  in  another.  Third,  we  judge  luxury 
differently  at  different  times.  There  is  a  continual  transfer 
of  articles  from  the  list  of  luxuries  into  that  of  comforts  and 
necessities.  This  transfer  is  brought  about  by  the  consensus 
of  social  judgment,  and  is  increasingly  acquiesced  in  by  all. 
So  we  see  that  the  term  "  luxury  "  does  not  apply  to  goods  of  a 
certain  character,  but  to  certain  goods  in  their  relation  of  time 
and  person.  For  the  purpose  of  discussion,  we  shall  define 
luxury  simply  as  excessive  personal  consumption. 

Our  definition  of  luxury  as  excessive  consumption  necessarily 
condemns  it  as  unjustifiable,  but  this  should  not  be  taken  as  a 
condemnation  of  an  enjoyment  of  more  than  the  simplest  kind  of 
life.  There  would  be  little  purpose  in  producing  wealth  in 
I  larger  and  larger  volume  if  it  did  not  mean  a  higher  and  better 
standard  of  life.  But  this  meaning  does  not  justify  the 
squandering  of  immense  sums  on  passing  caprices  whose  satis- 
faction cannot  be  justified  from  the  standpoint  of  what  is  a 
sane  life.  Nor  does  it  constitute  a  defense  of  ostentatious  ex- 
penditure. Extravagant  expenditure  is  sometimes  condoned 
on  the  ground  that  it  gives  employment  to  labor,  but  obviously 
just  as  much  employment  would  be  given  to  labor  by  an  equiv- 
alent expenditure  for  laudable  purposes.  Expenditures  for 
any  present  gratification  can  be  made  only  by  reducing  the 


144  OUTLINES  OF  ECONOMICS 

amount  either  of  other  expenditures  or  of  savings.  Rarely  in 
these  days  are  savings  hoarded  :  they  are  used  for  gainful,  often 
for  socially  productive,  purposes.  Extravagant  expenditures, 
therefore,  may  divert  productive  agencies  into  employments 
less  beneficial  to  society.  Moreover,  to  look  upon  expenditure 
as  desirable  because  it  gives  employment  to  labor,  or  "  puts 
money  in  circulation  "  and  "makes  trade  good,"  is  to  forget 
that,  ethically  viewed,  production  is  justified  only  through  the 
satisfaction  of  human  wants,  and  so  far  as  the  wants  satisfied 
are  trivial  or  worse  the  necessary  productive  effort  is  virtually 
wasted. 

Harmful  Consumption.  —  We  have  been  careful  to  avoid 
the  impression  that  luxury  consists  in  the  use  of  pernicious  goods. 
It  is  a  common  query,  "  Why  should  I  not  have  this  if  it  does 
me  no  harm?  "  This  we  have  tried  to  answer  in  the  preceding 
paragraphs.  A  luxury  may  be  a  positive  good  in  itself,  a  satis- 
faction which  society  may  well  hope  to  make  general,  but  it  is 
a  good  which  society  cannot  yet  afford,  because  other  and  greater 
wants  are  yet  unsatisfied.  But  there  is  another  kind  of  con- 
sumption which  is  objectionable  in  an  entirely  different  way, 
not  because  it  is  excessive  or  premature,  but  because  it  is  harmful 
in  itself.  Aside  from  the  fact  that  such  consumption  usually 
tends  to  diminish  the  sum  total  of  the  durable  satisfactions  that 
the  consumer  gets  out  of  life,  it  ordinarily  lowers  his  productive 
efficiency,  and  this  involves  a  further  loss  to  himself,  to  any  who 
may  be  dependent  upon  him,  and  to  the  whole  community. 

Statistics  of  Consumption.  —  Instructive  investigations  have 
been  made  as  to  the  relative  importance  of  the  leading  items 
in  the  family  budget.  The  late  Ernst  Engel,  the  former  dis- 
tinguished head  of  the  Prussian  Statistical  Bureau,  advanced 
the  theory  that  it  might  be  possible  by  a  careful  study  of  a  suffi- 
cient number  of  family  budgets  for  a  period  of  years  to  indicate 
the  broad  changes  in  consumption,  and  thus  by  a  sort  of  social 
signal  service  to  predict  the  coming  of  industrial  storms.  Noth- 
ing has  been  so  far  accomplished  along  this  line,  but  Engel's 
tables  are  important  in  other  ways.  From  Table  I  (page  145) 
he  deduces  the  following  four  propositions: 


CONSUMPTION 


145 


i.   The  greater  the  income,  the  smaller  the  relative  percen- 
tage of  outlay  for  subsistence. 

2.  The  percentage  of  outlay  for  clothing  is  approximately 
the  same,  whatever  the  income. 

3.  The  percentage  of  outlay  for  lodging  or  rent,  and  for  fuel 
and  light,  is  invariably  the  same,  whatever  the  income. 

4.  As  the  income  increases  in  amount  the  percentage  of  out- 
lay for  sundries  becomes  greater. 

TABLE   I 

Engel's  Statistics  —  Saxony 


Items  of  Expenditure 


1.  Subsistence 


2.  Clothing 

3.  Lodging 

4.  Heat  and  light      .     .     .     . 

5.  Education,  public  worship, 

etc 

6.  Legal  protection  .     .     .     . 

7.  Care  of  health 

8.  Comfort,  mental  and  bodily 

recreation 

Total 


Per  Cent  of  the  Expenditure  of  the 
Family  of 


A  Workingman 

with  an  Income 

of  from  S225 

to  $300  a  year 


A  Man  of  the 
Middle  Class 
with  an  Income 
of  from  S450 
to  S600  a  year 


62.0 
16.0 
12.0 


2.0 
1.0 
1.0 


95-° 


18.0 


3-5 

2.0 
2.0 


90.0 


A  Man  in  Easy 
Circumstances 

with  an  Income 
of  from  $750 

to  Siooo  a  year 


50.0 

18.0 

I2.o 

5-o 

5-5 
3-o 
3-° 

3-5 


*5-o 


The  reader  will  perceive  that  if  Engel's  table,  published  in 
1857,  had  been  constructed  in  recent  years,  somewhat  different 
limits  would  have  to  be  set  for  "  middle  class  "  incomes  even 
in  Germany. 

Subsequent  investigations  in  the  United  States  have  confirmed 
in  a  general  way  the  conclusions  of  Engel,  but  the  correspondence 
is  not  exact,  as  will  be  seen  from  Table  II,  from  the  reports  of 
the  United  States  Bureau  of  Labor,  summarizing  the  expendi- 
ture of  over  two  thousand  families  in  1891  and  over  eleven 
thousand  in  1903. 

L 


146 


OUTLINES  OF  ECONOMICS 


Table  III  gives  the  results  of  a  careful  study  of  the  budgets 
of  383  families  in  New  York. 

TABLE  n 

Expenditures  of  American  Families  Investigated  by  the  United 
States  Bureau  of  Labor 

(From  the  Seventh  [1891]  and  Eighteenth  [1903]  Annual  Reports) 


Per  Cent  oe  Total  Expenditure 

Income  Group 

Food 

Clothing 

Rent 

Fuel  and 
Light 

Miscella- 
neous 

1891 

1903 

1 891 

1903 

1891 

1903 

1891 

1903 

1891 

1903 

Under  $200 
$200-300   . 
S300-400   . 
S400-500   . 
$500-600   . 
$600-700   . 
S 700-800   . 
$800-900   . 
$900-1000 
$1000-1100 
$1100-1200 
$1200  or  over 

49.6 
44-3 
45 -6 
45- 1 
43-8 
41.2 

38.9 
38.1 
34-3 
34-7 
3°-7 
28.6 

50.9 
47-3 
48.1 
46.9 
46.2 

43-5 
41.4 

41.4 

39-9 
38.8 

37-7 
36-5 

12.8 

14-3 
1 4. 1 
14.4 
15-3 
15-9 
16.3 

16.8 

17-5 

16.5 

J5-7 

8.7 

8-7 
10.0 
11.4 
12.0 
12.9 

13-5 
13.6 

14.4 

14.9 
15-7 

15-5 
14.7 
15.0 

15-3 
15.2 

15-5 
15.6 
16.1 
14.9 

15-1 

12.2 
12.6 

16.9 
18.0 
18.7 
18.6 
18.4 
18.5 
18.1 
17. 1 
17.6 

17-5 
16.6 
17.4 

8.1 
7.6 
7.0 
6.6 
6.6 
5-9 
5-3 
5-3 
4-7 
4-5 
3-9 
3-o 

8.0 
7.2 

7-i 
6.7 
6.2 
5-8 
5-3 
5-o 
5-o 
4-9 
4-7 
5-o 

14.0 
19.2 
18.3 
18.6 
19.I 
21.6 

23-9 

25-5 
29.1 
28.1 

36.7 
40.1 

15-6 
18.8 
16.1 
16.5 
17.2 
19.4 
21.6 
23.0 
23.2 

23-7 
26.1 

25-4 

All     .     . 

41.4 

43-i 

15-3 

13.0 

i5-i 

18.1 

5-9 

5-7 

22.7 

20.1 

Consumption   and  Sacrifice.  —  Over  against  the  enjoyment 
resulting  from  wealth  consumption  lies  the  discomfort  of  wealth 

production.  Enjoyment,  we 
have  seen,  grows  less  and  less 
as  the  consumption  of  a  partic- 
ular good  is  continued,  but  the 
irksomeness  of  producing  it,  on 
the  contrary,  grows  greater  and 
greater  the  longer  labor  is  con- 
tinued. Let  us  take  the  case  of 
Robinson  Crusoe  picking  berries.  We  may  represent  the 
diminishing  utility  of  the  berries  to  him  by  the  line  ab  (Fig.  1), 
and  the  increasing  irksomeness  of  picking  them  by  the  line  cd 


Fig. 


CONSUMPTION 


r47 


TABLE   III 

Expenditures  of  Families  in  New  York  City  :  1907  l 


Expenditures 

• 

Income 
Group 

Food 

Cloth- 
ing 

Rent 

Fuel 

and 
Light 

Insur- 
ance 

Health 

Carfare 

Sun- 
dries 

Per  cent 

Per  cent 

Per  cent 

Per  cent 

Per  cent 

Percent  Percent 

Percent 

$400-499 

8 

40.8 

13.0 

26.8 

5-6 

1.2 

3-1 

2.6 

6.q 

$500-599 

17 

44.4 

12.4 

25-9 

5-9 

1-3 

1.9 

1.8 

6.4 

$600-699 

72 

44.6 

12.9 

23.6 

5-a 

2.0 

2.1 

1-7 

7-3 

$700-799 

79 

45-6 

13-4 

21.9 

5-o 

2-5 

1.9 

1-5 

8.2 

$800-899 

73 

44-3 

14.0 

20.7 

S-o 

2.2 

2.7 

2.0 

9.1 

$900-999 

63 

44-7 

14.6 

19.0 

5-i 

2.6 

2.6 

i-5 

9.9 

$1000-1099 

3i 

44-7 

'5-5 

18.1 

4-5 

2-5 

i-5 

1.8 

11.4 

$1100-1199 

18 

45-6 

14.9 

16.2 

3-a 

2-5 

3-6 

1.9 

"•5 

$1200-1299 

8 

45-c 

15.2 

19.8 

3.8 

2.2 

i-3 

i    2.2 

10.5 

$1300-1399 

8 

43-6 

13-7 

16.8 

*3-6 

4.9 

1.1 

1.1 

15.2 

$1500-1599 

6 

36.8 

16.8 

16.3 

4.1 

2-3 

7-4 

!      1.2 

i5-i 

He  would  not  pick  more  than  Ox,  because  the  .vth  berry  costs  him 
just  as  much  pain  as  it  yields  him  pleasure,  and  any  further 
continuance  of  gathering  fruit  would  result  in  an  excess  of 
pain.  The  degree  of  utility  represented  by  mx,  then,  repre- 
sents, at  the  moment  that  the  #th  berry  is  picked  and  eaten,  both 
the  marginal  utility  and  the  marginal  disutility,  or  marginal 
pain  or  sacrifice. 

Each  of  us  has  sometimes  made  such  comparisons  —  bal- 
ancing the  pleasure  of  further  consumption  against  the  pain  of 
further  production.  Many  persons  who  are  working  eight  or 
ten  hours  a  day  could  increase  their  income  somewhat  by  work- 
ing twelve  hours,  but  the  additional  discomfort  is  greater  in 
their  estimation  than  the  additional  fruits  of  their  labor  would 
be  worth.  To  be  sure,  much  of  our  economic  action  goes  on 
unconsciously.  We  accept  a  position,  comparing  its  advantages 
and  its  disadvantages  in  a  general  way  with  those  of  other 
openings,  but  once  we  enter  upon  the  work,  we  accept  the 
daily  grind  as  inevitable,  and,  in  spending  our  income,  think 

1  R.  C.  Chapin,  The  Standard  of  Living  in  New  York  City,  p.  70. 


y    > 


148  OUTLINES  OF  ECONOMICS 

not  of  the  sacrifices  it  has  cost  us,  but  simply  of  how  we  can 
get  the  maximum  satisfaction  from  it. 

In  discussing  future  wants  we  saw  that  postponing  the  con- 
sumption of  goods  from  the  present  to  the  future  came  to  re- 
quire compensation  only  after  a  certain  amount  had  been  saved. 
Under  present  methods  of  production,  it  was  explained  in  the 
preceding  chapter,  a  large  amount  of  this  postponement  of 
consumption  is  required.  Machines  must  be  made,  and  the 
result  of  this  labor  cannot  be  enjoyed  until  these  machines  have 
been  used  up  in  making  finished  products.  This  means  that 
some  one  must  wait  for  the  result,  and  in  many  cases  be  paid 
to  do  it.  Thus  production  may  require,  in  addition  to  com- 
pensation for  labor,  a  payment  for  waiting.  This  is  a  point 
which  will  be  discussed  further  in  the  chapter  on  interest. 

Cost  of  Production,  Expense  of  Production,  and  Opportunity 
Cost.  —  The  preceding  paragraphs  explain  one  important 
sense  in  which  the  term  "  cost  of  production  "  is  used,  i.e.  (1) 
the  subjective  cost  of  irksome  labor  or  reluctant  waiting.  But  (2) 
the  phrase  is  also  commonly  used  to  refer  to  the  expense  of 
production,  that  is,  the  amount  of  money  spent  in  producing  a 
commodity.  (3)  A  third  meaning  is  also  found,  which  has  been 
termed  opportunity  cost.  Let  us  say  that  a  person  is  confronted 
by  the  alternative  of  engaging  in  either  of  two  occupations. 
He  may  become  a  lawyer  or  he  may  become  a  merchant,  but 
he  has  not  the  time  to  be  both.  If  he  chooses  to  be  a  lawyer, 
he  sacrifices  his  opportunity  of  being  a  merchant.  Cost  in 
this  sense  is  sometimes  called  "  alternative  cost,"  or  "  displace- 
ment cost."  This  is  not  an  ultimate  cost,  but  it  probably  has 
a  more  direct  and  more  important  influence  upon  most  of  our 
economic  choices  and  decisions  than  has  any  other  kind  of  cost. 
Moreover,  in  the  actual  conduct  of  life  opportunity  cost  and 
direct  cost  are  generally  inextricably  blended.  The  increasing 
irksomeness  of  Crusoe's  task  of  picking  berries,  for  example, 
may  be  deemed  to  have  been  caused  in  large  measure  by  the 
pressure  of  other  demands  upon  his  time.  We  haven't  time 
enough  to  do  all  the  things  we  should  like  to  do,  and  so  we  have 
to  apportion  our  time  according  as  we  think  that  one  use  of 


CONSUMPTION  149 

it  or  another  is  the  more  important.  And,  in  general,  we  try- 
so  to  apportion  our  time  that  the  fruits  of  the  last  or  marginal 
increment  of  time  devoted  to  any  one  purpose  shall  have  no 
more  or  no  less  utility  than  those  of  the  marginal  unit  of  time 
devoted  to  any  other  purpose. 

Taking  "  leisure  "  as  a  collective  name  for  all  of  the  non- 
economic  uses  of  time,  that  is,  for  all  uses  of  time  for  other  than 
productive  or  money-making  purposes,  it  appears  clearly  that 
a  worker  with  free  command  of  his  time  will  carry  his  chosen 
line  of  effort  up  to  the  point  (or  margin)  where  leisure  attracts 
him  as  much  as  the  products  of  his  exertion,  or,  in  modern 
economic  life,  as  the  things  he  can  acquire  with  the  money  he 
earns.  As  in  the  expenditure  of  money,  so  in  the  expenditure 
of  time  and  effort :  we  tend  to  bring  our  expenditures  up  to 
margins  where  utilities  gained  and  utilities  sacrificed  or  foregone 
are  equal. 

QUESTIONS  AND  EXERCISES 

1.  If  you  had  four  sacks  of  corn  all  alike,  could  you  tell  which  is  the 
marginal  one? 

2.  May  one  properly  speak  of  the  marginal  utility  of  an  indivisible  good, — 
a  house,  for  example? 

3.  If  an  individual  estimates  his  present  wants  as  10,  8,  6,  3,  1,  and  his 
future  wants  as  equivalent  to  the  present  value  of  9,  7,  5,  2,  o,  and  if  he  has 
$9,  and  if  each  want  is  satisfied  with  $1,  how  many  dollars  will  he  save? 

4.  Give  as  many  expressions  as  possible  that  are  equivalent  to  the  term 
"subjective  value." 

5.  Comment  on  the  following:  "Doubtless  the  best  thing  to  do  about 
them  (the  spendthrifts)  is  to  do  nothing  —  not  even  to  worry  about  their 
waste  of  money.  Their  waste  of  money,  in  fact,  is  the  least  silly  thing  they 
do,  for  the  money  is  in  constant  flux  and  serves  its  purpose."  World's 
Work,  June,  1906. 

6.  Comment  on  the  following  words  of  Adam  Smith:  "Nothing  is  more 
useful  than  water;  but  it  will  purchase  scarce  anything;  scarce  anything 
can  be  had  in  exchange  for  it.  A  diamond,  on  the  contrary,  has  scarce  any 
value  in  use,  but  a  very  great  quantity  of  goods  may  frequently  be  had  in 
exchange  for  it."     Wealth  of  Nations,  Book  I,  Chap.  iv. 

7.  Point  out  the  differences  in  the  tables  of  consumption  statistics  quoted 
in  the  text.  How  do  they  modify  EngePs  statements  ?  Suggest  explanations 
of  these  differences. 


150  OUTLINES  OF   ECONOMICS 

REFERENCES 

Bohm-Bawerk,  E.  vox.     Positive  Theory  of  Capital,  Book  iii,  Chaps,  iii 

and  iv. 
Chapix,  R.  C.     The  Standard  of  Living  in  New  York  City. 
Davenport,  H.  J.     Economics  of  Enterprise,  Chaps,  vii,  viii. 
Hobsox,  J.  A.     Tlie  Social  Problem,  Book  ii,  Chap.  vii. 
Jevoxs,  H.  S.     Essays  in  Economics,  Chaps,  ii,  iii. 
Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Book  iii. 
Mayo-Smith,  Richmoxd.    Statistics  and  Economics,  Book  i,  Chap.  ii. 
More,  L.  B.     Wage-Earners'  Budgets. 
Rowxtree,  B.  S.     Poverty,  Chaps,  vi-viii. 
Streighthoff,  F.  H.     Tiie  Standard  of  Living  among  the  Industrial  People 

of  America,  Chap.  ii. 
Urwick,  E.  J.     Luxury  and  Waste  of  Life,  Chap.  iii. 
Veblex,  Thorsteix.     Tlie  Theory  of  the  Leisure  Class. 
Watkins,  G.  P.     Welfare  as  an  Economic  Quantity,  Chaps,  i,  iv. 
Wicksteed,  P.  H.     The  Common  Sense  of  Political  Economy,  Book  i,  Chaps. 

i.  iii. 
Withers,  H.    Poverty  and  Waste,  Chap.  viii. 


PART   II 

VALUE   AND   EXCHANGE 

CHAPTER  X 
VALUE   AND    PRICE 

If  every  family  produced  all  the  goods  needed  to  supply  tlP* 
wants  of  its  members,  most  of  the  problems  which  today  con- 
front economic  science  would  not  exist.  Most  of  the  world's 
workers  are,  however,  contributing  their  services  either  directly 
or  indirectly  (through  the  production  of  goods)  toward  the 
satisfaction  of  the  wants  of  others.  One's  economic  well- 
being  today  depends  primarily  on  two  things:  the  money  in- 
come which  can  be  got  from  others  in  return  for  one's  services 
or  for  the  use  of  one's  land  or  capital,  and  the  amount  of  things 
that  can  be  bought  with  this  money  income.  The  federal  census 
of  1 910  showed  that  about  93  per  cent  of  the  men  over  twenty 
years  old  and  about  18  per  cent  of  the  women  of  corresponding 
age  were  employed  in  money-making  occupations ;  and  this 
number  does  not  include  those  landlords  and  capitalists  whose 
income  was  derived  entirely  from  their  investments.  The  work 
of  the  housewife  and  the  services  of  friendship  embody  utilities, 
that  is,  satisfy  human  wants,  just  as  do  money-making  activities, 
but  they  are  not  reported  in  terms  of  dollars  and  cents.  The 
production  of  wealth  is  in  these  days  mostly  "  for  the  market," 
and  wants  are  satisfied  very  largely  by  goods  obtained  from  the 
market.  In  the  vast  interlocking  system  of  modern  economic 
life  most  goods  get  from  those  who  produce  them  to  those  who 
use  them  by  the  processes  of  exchange. 

The  Meaning  and  Significance  of  Value.  —  It  rarely  happens 
nowadays  that  goods  are  directly  exchanged  for  other  goods. 

151 


152  OUTLINES  OF  ECONOMICS 

Goods  are  usually  sold  for  money,1  and  the  seller  uses  the  money 
in  the  purchase  of  other  goods.  The  amount  of  money  for  which 
a  unit  of  a  given  commodity  exchanges  is  the  price  of  that  commodity. 
Since  prices  vary,  when  we  wish  to  name  the  actual  price  of 
any  commodity  we  must  specify  the  price  in  a  given  market  at  a 
given  time. 

From  this  simple  and  familiar  concept  of  price  there  has  been 
developed  the  more  general  concept  of  exchange  value.  If  a 
hat  sells  for  two  dollars,  a  pair  of  shoes  for  four  dollars,  and  a 
pocket  knife  for  fifty  cents,  we  say  that  the  exchange  value  of 
the  hat  is  half  that  of  the  pair  of  shoes  and  four  times  that  of  the 
knife.  It  thus  comes  about  that  we  attribute  exchange  values 
to  goods  in  accordance  with  their  relative  potency  in  exchange, 
as  shown  by  the  prices  at  which  they  sell.  In  this  way  values 
come  to  be  thought  of  as  magnitudes.  Just  as  weight  and 
volume  are  physical  magnitudes  by  which  we  express  the  rela- 
tive heaviness  and  the  relative  bulk  of  different  objects,  so  ex- 
change values  are  economic  magnitudes  or,  more  specifically, 
exchange  magnitudes.  The  exchange  value  of  a  good  is  thus 
the  resultant  of  its  exchange  relations  with  other  goods. 

Exchange  value  is  a  purely  relative  or  comparative  magnitude, 
and  there  is  no  way  of  expressing  or  measuring  the  exchange 
value  of  a  good  except  in  terms  of  its  command  over  other  goods. 
In  such  a  measurement  exchange  value  can  be  expressed  either  as 
a  quantity  or  as  a  ratio.  We  can  say  (i)  that  the  value  of  a  pair 
of  shoes  is  that  of  eight  knives  or  (2)  that  the  value  of  the  shoes 
is  to  the  value  of  a  knife  as  eight  is  to  one.  We  thus  express  the 
exchange  value  of  any  good  either  by  stating  the  quantity  of 
other  goods  that  can  be  obtained  for  it  or  by  stating  its  ratio 
of  exchange  with  other  goods.  The  exchange  value  of  any  one 
commodity  can,  of  course,  be  expressed  in  terms  of  any  other 
commodity.  Price  is  a  statement  or  expression  of  exchange 
value  in  terms  of  money.  To  say  that  the  price  of  a  pair  of 
shoes  is  four  dollars  amounts  to  saying  that  the  value  of  the  pair 
of  shoes  is  four  times  the  value  of  a  dollar.     When  the  words 

1  In  this  chapter  the  word  "  money  "  is  used  in  its  broadest  sense,  thus  including 
credit  instruments,  which  are,  of  course,  merely  promises  to  pay  money. 


VALUE  AND   PRICE  1 53 

"  value  "  and  "  pn^.e  "  are  u  ed  interchangeably,  as  will  some- 
times be  our  practice  in  this  book,  there  is  implied  the  assump- 
tion that  the  value  of  money  as  expressed  in  terms  of  other  things 
than  the  particular  commodity  w  2  are  discussing  is  constant,  — 
an  assumption  which,  of  course,  does  not  entirely  correspond 
with  the  facts. 

Exchange  values  are  determined  by  what  may  be  called 
the  "price  process."  This  term  is  used  in  a  narrow  sense  as 
referring  to  the  fixing  of  the  money  values  of  commodities; 
in  a  broader  sense  it  includes  also  the  determination  of  the 
different  rewards  received  by  those  who  have  contributed  to  the 
production  of  these  commodities.  In  this  broad  sense  the  prob- 
lem of  prices  is  the  problem  of  the  distribution  of  wealth. 
Imagine  the  case  of  a  mechanic  employed  at  a  particular  time  in 
the  manufacture  of  machinery  that  will  be  used  in  a  flour  mill. 
The  final  product  of  the  mechanic's  labor  —  the  only  product 
directly  useful  in  the  satisfaction  of  human  wants  —  is  the  flour, 
or  bread  made  from  the  flour.  To  the  making  of  this  final  prod- 
uct thousands  besides  our  mechanic  —  farmers,  agricultural  la- 
borers, railway  officers  and  employees,  other  mechanics,  and  so 
on  in  a  practically  endless  list  —  have  contributed.  What  deter- 
mines the  price  of  the  final  product?  What  proportion  of  this 
price  goes  to  the  mechanic  ?  What  is  his  share  worth  to  him  as 
the  means  of  getting  the  necessaries  of  life  ?  Of  these  three  ques- 
tions, the  first  and  third  fall  within  the  problem  of  the  prices 
of  commodities ;  the  second,  relating  to  the  wage-price  of  the 
mechanic's  services,  falls  within  the  problem  of  the  distribution 
of  wealth.  At  present  we  are  concerned  only  with  prices  in  their 
narrower  sense,  although  the  principles  to  be  developed  apply 
also  in  the  case  of  the  prices  paid  for  the  services  of  the  factors  in 
production.  The  significance  of  the  subject  of  value  in  economic 
science  lies  in  the  fact  that,  within  the  conditions  set  by  existing 
institutions,  and  within  the  limits  set  by  the  total  production  of 
wealth,  human  welfare,  so  far  as  it  is  dependent  upon  the  pos- 
session of  economic  goods,  is  largely  determined  by  the  process 
of  fixing  price  relations. 

The   Market.  —  It  is  conceivable  that  the  prices  of  goods 


154  OUTLINES  OF   ECONOMICS 

might  be  fixed  by  public  authority,  or  that  the  production  of 
the  most  important  commodities  might  be  monopolized.  Then, 
too,  it  is  possible  to  imagine  a  condition  of  society  in  which 
custom  should  have  such  power  that  prices,  when  once  estab- 
lished, would  be  changed  very  infrequently.  Still  another 
possibility  is  a  regime  of  competition  in  which  every  man  is 
left  free  to  buy  and  sell  as  he  pleased  at  such  prices  as  he  can 
get.  The  first  three  factors  —  public  authority,  monopoly, 
and  custom  —  are  among  the  things  which  determine  the  ratios 
at  which  goods  are  actually  exchanged  today ;  but  the  dominant 
factor  is  the  fourth  one  mentioned  —  the  free  competition  of 
the  market. 

In  this  connection  we  mean  by  the  market,  not  a  particular 
place  for  buying  and  selling,  but  the  general  field  within  which  the 
forces  determining  the  price  of  a  particular  commodity  operate.  For 
some  commodities,  especially  perishable  ones,  like  fresh  milk  and 
cream,  the  market  is  distinctly  a  local  one.  In  the  case  of  great 
staple  commodities  like  wheat  and  cotton,  the  market  is  a  world 
market,  for  it  is  impossible  that  the  prices  of  wheat  or  cotton  in 
Europe  should  differ  for  any  considerable  time  from  their  prices 
in  America  by  more  than  the  expense  of  transport.  So-called 
<(  international  "  securities,  such  as  government  bonds  and  the 
stocks  and  bonds  of  certain  great  corporations,  afford  even  a 
better  example  of  goods  for  which  the  market  is  a  world  market. 
Some  commodities  are  used  only  in  a  particular  locality  or 
country,  although  produced  in  many  different  places.  The 
American  consular  reports  frequently  contain  advice  to  Ameri- 
can manufacturers  as  to  special  kinds  and  varieties  of  goods  used 
in  different  foreign  countries.  The  cotton  mills  of  England, 
Germany,  and  the  United  States  all  make  special  grades  of 
cotton  cloth  designed  especially  for  the  Oriental  market.  Much 
more  numerous,  however,  are  the  goods  which,  although  of 
wide  and  general  consumption,  are  produced  in  but  few  localities. 
This  is  especially  evident  in  the  case  of  agricultural  and  mineral 
products,  but  it  is  increasingly  noticeable  in  manufactures. 

Along  with  this  localization  of  industry  there  has  been  a 
broadening  of  the  field  of  consumption  of  many  commodities. 


VALUE  AND   PRICE  1 55 

Among  the  factors  which  have  contributed  to  this  result  may  be 
mentioned,  first,  the  increasingly  cosmopolitan  character  of 
modern  life,  —  a  result  of  more  generally  diffused  facilities  for 
higher  education,  as  well  as  of  the  growing  ease  of  travel  and 
communication ;  and  secondly,  what  has  been  called  the 
"  standardization  of  taste,"  —  a  result  in  part  of  modern  ad- 
vertising methods  and  of  the  standardization  of  products 
which  is  one  of  the  fundamental  features  of  modern  machine 
industry.  Notwithstanding  the  barriers  which  still  exist  in 
the  form  of  protective  tariffs  and  local  prejudices,  a  dominant 
feature  of  modern  markets  is  the  increasing  localization  of 
production  and  the  extension  of  the  field  of  consumption. 

Exchange  Value  and  Subjective  Value.  —  Exchange  value  is 
often  called  market  value  or  objective  value,  and  is  sharply  to  be 
distinguished  from  subjective  value,  which,  it  will  be  remem- 
bered, is  the  relative  importance  attached  by  an  individual  to 
a  particular  unit  of  a  commodity.  Exchange  value  is  an  objec- 
tive, ascertainable  fact  of  the  market.  Subjective  value  is  a 
matter  of  individual  feelings  and  preferences,  and  is  different 
for  different  individuals.  An  error  which  we  must  especially 
guard  against  is  that  of  thinking  that  exchange  values  are  in 
any  accurate  sense  the  expression  of  the  subjective  values  of 
different  goods  to  society  at  large.  Exchange  value  is  the  out- 
come, the  resultant,  of  the  individual  subjective  valuations  of 
many  different  persons,  the  poor  and  the  rich,  the  wise  and  the 
foolish,  but  it  does  not  correspond  to  "  social  subjective  value," 
or  "  social  marginal  utility,"  for  these  two  last  phrases  are 
meaningless.  It  is  true,  of  course,  that  our  own  valuations 
are  largely  socially  determined  in  the  sense  that,  lacking  much 
real  independence  of  judgment,  we  follow  and  imitate  other 
people  in  making  our  own  estimates  of  the  relative  desirability 
of  different  commodities,  and  that  we  are  even  prone  to  judge 
of  the  relative  importance  of  different  things  for  our  own  pur- 
poses by  their  costliness,  that  is,  by  their  exchange  values, 
rather  than  by  an  independent  analysis  of  our  own  needs.  But 
the  differences  in  our  tastes  and  the  differences  in  our  powers 
to  gratify  our  tastes  are  quite  as  important  factors  in  determining 


156  OUTLINES  OF  ECONOMICS 

the  exchange  values  of  things  as  are  our  similarities.  Just 
what  is  the  point  of  connection  between  subjective  values  and 
exchange  values  we  shall  discover  in  the  analysis  of  supply 
and  demand. 

Supply  and  Demand.  —  The  only  goods  which  are  valued  in 
the  market  are  economic  goods ;  that  is,  such  goods  as  combine 
the  characteristics  of  utility  and  scarcity.  This  statement  is 
a  truism,  for  no  one  will  pay  for  things  that  he  does  not  want  or 
for  things  that  can  be  obtained  freely.  Utility  and  scarcity 
affect  the  market  value  of  goods  through  the  operation  of  the 
forces  of  demand  and  supply.  The  general  "  common-sense  " 
explanation  of  the  valuation  of  goods  takes  the  form  of  the 
statement  that  values  are  determined  by  supply  and  demand. 
When  rightly  interpreted,  this  statement  cannot  be  criticized, 
but  it  is  often  used  in  a  misleading  way.  Producers  do  not 
usually  throw  a  "  supply  "  of  goods  unreservedly  on  the  market, 
accepting  any  price  that  can  be  got  for  them,  nor  do  consumers 
generally  demand  definite  amounts  of  goods,  without  reference 
to  the  price  of  them.  An  entirely  accurate  statement,  and  one 
that  is  less  apt  to  be  misinterpreted,  is  that  prices  are  among  the 
factors  determining  supply  and  demand.  It  may  seem,  accord- 
ingly, something  like  arguing  in  a  circle  to  attempt  to  explain 
exchange  value  by  using  the  formula  of  supply  and  demand ; 
but  the  fact  is  that  the  explanation  is  to  be  sought  in  the  action 
of  mutually  dependent  forces,  rather  than  in  any  one  principle. 

The  Nature  of  Demand.  —  Mere  desire  for  a  commodity  is 
not  demand  for  it.  The  desire  of  the  poor  man  for  the  counter- 
part of  his  wealthy  neighbor's  motor  car  is  in  no  sense  demand. 
Effective  demand  is  sometimes  defined  as  desire  coupled  with  the 
ability  to  pay.  But  to  make  demand  really  effective  there 
must  be  added  to  these  the  inclination  to  buy :  desire  must  be 
intense  enough  to  lead  to  purchase. 

If  I  purchase  a  certain  quantity  of  a  particular  commodity,  it 
is  because  I  desire  it  at  least  as  intensely  as  anything  else  I  can 
purchase  with  the  same  amount  of  money.  When  I  ask  myself 
whether  a  certain  contemplated  purchase  is  "  worth  its  price  "  to 
me,  I  am  comparing  the  importance  of  the  purchase  in  question 


VALUE   AND   PRICE  1 57 

with  the  importance  of  other  uses  of  the  money  which  the 
price  represents.  It  is,  in  other  words,  a  matter  of  my  subjec- 
tive valuations.  Now  my  subjective  valuations,  it  will  be 
remembered,  depend  not  only  upon  my  tastes  and  my  purposes, 
but  also  (on  account  of  the  law  of  diminishing  utility)  upon  the 
extent  to  which  I  am  already  supplied  with  goods  like  that 
whose  purchase  I  am  considering,  as  compared  with  the  extent 
to  which  I  am  supplied  with  other  things.  In  choosing  and 
picking  among  the  different  alternatives  open  to  me  as  a  pur- 
chaser, in  buying  one  thing  rather  than  another,  in  acquiring 
more  of  this  and  less  of  that,  I  merely  express  my  subjective 
valuations.  A  certain  minimum  supply  of  one  commodity  — 
a  necessity  of  life,  perhaps  —  may  be  more  important  to  me, 
may  possess  a  higher  utility,  than  any  possible  amount  of  some 
other  commodity,  —  a  luxury,  for  example.  But  I  may  deem 
it  less  important  to  have  a  large  supply  of  the  first  commodity 
than  to  have  some  of  the  second  commodity.  If  I  push  my 
expenditures  for  any  one  purpose  too  far,  I  sacrifice  the  satis- 
faction of  more  important  wants  for  the  satisfaction  of  less 
important  wants.  Think  of  one's  purchases  as  being  divided, 
not  into  such  units  as  pounds,  bushels,  yards,  and  dozens,  but 
into  units  defined  by  the  quantity  one  can  purchase  for  a  dollar, 
—  into  "dollar's  worths."  Each  of  us,  by  buying  the  things 
he  wants  more  than  he  wants  other  things,  tends  to  keep  the 
subjective  values  of  the  last  or  marginal  dollar's  worths  of  all 
the  different  kinds  of  goods  he  consumes  equal,  one  to  another. 
As  our  tastes  and  desires  and  purposes  change  we  alter  our 
scheme  of  expenditures  accordingly,  but  always  so  that  our 
marginal  dollar's  worths  are  kept,  as  it  were,  in  equilibrium. 
But  even  if  our  desires  were  constant,  changes  in  prices  would  in 
themselves  effect  continual  alterations  in  the  proportions  of 
various  things  that  make  up  our  purchases.  The  various  dollar's 
worths  become  larger  or  smaller  and  acquire  larger  or  smaller 
subjective  values.  If  the  price  of  a  commodity  decreases  to 
such  an  extent  that  an  additional  dollar's  worth  gains  a  subjec- 
tive value  greater  than  that  of  other  dollar's  worths,  we  normally 
purchase  it.     If  the  price  rises,  we  normally  curtail  our  ex- 


i58 


OUTLINES  OF  ECONOMICS 


A 

A" 


penditures  for  this  particular  commodity,  and  may  even,  under 
some  circumstances,  become  sellers  of  it  (as  in  the  case  of  the 
householder  who  has  bought  a  large  supply  of  coal  at  five  dollars 
per  ton,  and  who,  when  the  price  rises  to  ten  dollars,  is  willing  to 
sell  part  of  it).  Some  of  the  foregoing  discussion  may  seem  to 
be  a  statement  of  what  is  obvious  and  commonplace,  but  the 
neglect  of  these  seemingly  obvious  factors  is  responsible  for 
more  than  one  erroneous  explanation  of  the  way  in  which  prices 
are  determined. 

The  Demand  Curve.  —  The  relations  between  price  and  de- 
mand may  be  shown  concretely  by  the  analysis  of  the  condi- 
tions in  a  hypothetical  market.     Imagine  the  case  of  an  isolated 

community  in  which  wood 
is  used  as  a  fuel.  The 
conditions  might  be  such 
as  are  represented  graphi- 
cally in  Figure  i.  In  this 
diagram  distances  meas- 
ured from  O  along  the 
horizontal  line  OX  rep- 
resent different  amounts 
of  wood,  while  distances 
measured  vertically  from  the  line  OX  represent  prices.  Assum- 
ing that  the  conditions  of  demand  were  as  represented  in  the 
diagram,  if  the  price  of  wood  were  MP  dollars  a  cord,  OM  cords 
of  wood  would  be  bought.  If  MP  represents  a  relatively  high 
price  for  wood,  this  might  mean  that  many  families  would 
choose  to  go  without  wood,  using  other  kinds  of  fuel  instead. 
Others  would  be  content  with  a  scanty  supply.  If,  however, 
the  price  were  reduced  to  M'P'  dollars  per  cord,  some  of  the 
families  who  would  have  refused  to  buy  at  the  higher  price  would 
purchase  wood,  while  others  would  increase  their  purchases,  so 
that  OM'  cords  would  be  bought.  Similarly,  at  the  price 
M"P",  the  amount  bought  would  be  OM"  cords.  Other  pos- 
sible prices  might  be  indicated  on  the  diagram,  so  that,  in 
general,  the  curve  DD'  (which  we  may  call  the  demand  curve) 
represents  the  relation  between  price  and  the  amount  purchased. 


J) 

p 

J>' 

p" 

^ — Ml 

31'  M" 
Fig. 


VALUE   AND   PRICE 


159 


p 

V 

— D' 

A 


M 


X 


Fig.  2. 


More  definitely,  the  demand  curve  represents  the  amount  of  a 
given  commodity  which  can  be  sold  In  a  given  market  at  each 
of    all    possible 
prices. 

The  Elasticity 
of  Demand.  — . 
By  the  elasticity 
of  demand  we 
mean  the  extent 
to  which  the 
amounts  pur- 
chased vary 
with  changes  in 
price.  In  every 
family   in   poor 

or  moderate  circumstances  the  housewife  carefully  economizes 
in  the  use  of  eggs  during  periojs  when  tftey  are  nigh  in  price, 
using  them  more  freely  when  the  price  is  lower.  The  demand  for 
eggs  is  therefore  clastic.     Relatively  inelastic  are  the  demands 

of  most  families  for  such 
things  as  flour  and  salt. 
Other  commodities,  such  as 
sugar,  may  occupy  an  inter- 
mediate position.  Figures 
2  and  3  represent,  respec- 
tively, elastic  and  inelastic 
conditions  of  demand.  It 
should  be  understood  that 
the  demand  curves  for  most 
commodities  are  probably 
not  so  smooth  and  regular 
in  their  slope  as  are  these 
diagrams.  It  may  often 
happen  that  the  elasticity 
of  demand  is  different  for  different  portions  of  the  demand 
curve.  The  demand  for  bread,  for  example,  would  probably 
be  much  more  elastic  at   very  high  prices    than  at  very  low 


160  OUTLINES   OF   ECONOMICS 

prices.  The  demand  for  salt,  on  the  contrary,  would  prob- 
ably be  less  elastic  at  prices  so  high  that  it  would  be  used  only 
as  a  food  than  at  prices  low  enough  to  permit  its  use  (as  at  pres- 
ent) for  various  industrial  purposes.  Without  giving  further 
concrete  examples,  the  following  propositions  respecting  elas- 
ticity of  demand  may  be  stated :  (i)  Demand  for  necessities 
is  in  general  less  elastic  than  demand  for  luxuries.  (2)  Demand 
for  commodities  the  use  of  which  constitutes  a  habit  is  less 
elastic  than  demand  for  commodities  the  use  of  which  is  gen- 
erally a  matter  of  conscious  decision.  (3)  The  more  adequate 
the  substitutes  for  a  particular  commodity,  the  more  elastic 
will  be  the  demand  for  it.  (4)  The  demand  of  persons  of  large 
income  is  less  elastic  than  that  of  persons  in  poor  or  moderate 
circumstances.  (5)  A  corollary  of  proposition  four  is  that  the 
higher  the  general  level  of  well-being  in  a  community,  the  less 
elastic  will  be  the  demand  for  most  commodities. 

The  rectangle  OMPA  (in  any  one  of  the  three  diagrams) 
represents  the  total  amount  buyers  pay  for  a  certain  commodity 
when  the  price  is  MP,  just  as  the  rectangle  OM'P'A'  represents 
the  total  amount  paid  when  the  price  is  M'P'.  If  the  demand 
for  the  commodity  is  distinctly  inelastic,  this  total  value  will  be 
less  when  the  price  is  low  than  when  the  price  is  high.1  At 
the  lower  price  less  money  will  be  expended  for  this  particular 
commodity  and  more  money  will  be  available  for  other  uses.  If, 
on  the  other  hand,  the  relations  between  price  and  demand  are 
such  that  the  rectangle  OM'P'A'  is  larger  than  the  rectangle 
OMPA,  a  drop  in  price  from  MP  to  M'P'  will  result  in  a 
curtailing  of  expenditures  for  other  things.  This  might  involve 
only  a  decreased  use  of  direct  substitutes,  such  as  coal  in  place 
of  wood ;  generally,  however,  it  would  mean  a  diminished  con- 
sumption of  a  number  of  other  things.     But  this  is  a  gain,  not 

1  Elasticity  of  demand  may  be  represented  mathematically  by  a  fraction  whose 
denominator  is  the  relative  (or  percentage)  decrease  in  price  and  whose  numerator 
is  the  corresponding  relative  increase  in  the  amount  demanded.  Following  the  nota- 
tion used  in  Figures  2  and  3,  this  is  the  ratio  of  MM'/OM  to  AA'/AO.  When  the 
elasticity  of  demand,  thus  expressed,  is  equal  to  MM'/OM  +  1,  the  rectangles 
OMPA  and  OM'P'A'  are  equal;  that  is,  the  same  total  amount  is  expended  for 
the  commoditv  when  the  price  is  MP  as  when  the  price  is  M'P'. 


VALUE  AND   PRICE  l6l 

a  loss.  For  the  lower  price  would  not  be  accompanied  by  the 
purchase  of  a  larger  quantity,  if  the  additional  purchases  did 
not  satisfy  more  intense  wants  than  other  things  that  might 
have  been  purchased  with  the  money.  Larger  "  dollar's 
worths  "  will  have  been  substituted  for  smaller  ones. 

In  this  way  the  demand  for  any  one  commodity  is  affected 
by  changes  in  the  prices  of  other  commodities.  The  competition 
of  the  market  thus  embraces  not  only  the  buying  and  selling 
of  one  commodity,  but  also  the  buying  and  selling  of  all  com- 
modities. In  this  sense  the  wood  dealers  compete  with  the 
grocers  and  the  tailors,  as  well  as  with  the  coal  dealers  and  with 
each  other. 

Consumers'  Surplus.  —  Whatever  the  price  of  a  competitively  produced 
commodity  may  be,  there  are  almost  always  some  buyers  who  would  have 
paid  more  if  it  had  been  necessary.  Referring  to  Figure  i,  if  the  price  is 
M'P',  those  who  are  just  willing  to  pay  that  price,  who  would  either  have 
bought  less  or  bought  none  if  the  price  had  been  higher,  may  be  called  the 
marginal  buyers.  These  are  relatively  few  in  number,  however,  as  compared 
with  those  who  would  have  bought  even  if  the  price  had  been  higher.  The 
utility  of  the  marginal  purchases  to  the  buyers  is  but  little  more  than  the 
utility  of  other  things  that  could  have  been  bought  with  the  same  amount  of 
money  :  in  such  cases  the  utility  of  the  purchase  only  about  equals  the  sacri- 
fice involved.  In  the  case  of  all  other  purchases,  however,  there  is  a  surplus 
of  utility  over  costs  (whether  costs  are  measured  as  money  costs  or  as  the 
utility  of  the  other  possible  purchases  which  are  given  up)  which  is  called 
consumers'  surplus  (or  sometimes  consumers'  rent,  or  buyers'  gains). 

It  might  be  supposed  at  first  thought  that  if  the  price  were,  for  example, 
M'P'  (Fig.  i),  the  area  included  between  the  horizontal  line  A'P'  and  the 
curve  DP1  would  represent  consumers'  surplus.  This  is  not  exactly  true, 
however,  and  that  for  two  reasons :  in  the  first  place,  the  satisfaction  of 
additional  wants  which  a  lower  price  makes  possible  may  make  the  more 
important  wants  less  intense.  A  man  might  be  willing  to  give  ten  dollars 
for  a  cord  of  wood  in  order  that  at  least  one  room  in  his  house  could  be  heated 
during  the  winter.  He  might  also  be  willing  to  give  seven  dollars  a  cord  for 
two  cords,  so  as  to  heat  two  rooms,  but  the  heating  of  the  second  room  might 
render  the  heating  of  the  first  room  less  important  to  him.  He  might  not 
be  willing,  for  example,  to  give  ten  dollars  plus  seven  dollars  in  order  to 
have  the  two  rooms  heated.  In  the  second  place,  utility  itself  is  to  a  large 
extent  affected  by  price.  So  far  as  our  purchases  satisfy  what  has  been 
called  the  desire  for  distinction,  or  represent  what  Professor  Thorstein 
Veblen  has  called  "conspicuous  consumption,"  a  lowering  of  the  price  of  a 
M 


162  OUTLINES  OF  ECONOMICS 

commodity  would  lessen  its  utility  to  us.  The  successful  production  of 
artificial  diamonds  at  a  low  cost  would  lessen  the  desire  which  most  people 
have  for  natural  ones.  If  touring  cars  were  less  an  indication  of  one's 
ability  to  spend  money  freely,  they  would  be  less  esteemed  by  not  a  few 
people.  On  the  other  hand,  it  might  occur  in  some  cases  that  a  certain 
amount  of  decrease  in  the  price  of  a  commodity,  permitting  a  more  general 
consumption  of  it,  would  increase  the  esteem  in  which  it  is  held  by  those 
who  are  glad  to  follow  fads.  In  general,  we  must  say  that  even  if  we  had 
absolutely  complete  statistics  of  the  actual  relation  of  prices  to  demand, 
consumers'  surplus  would  still  be  an  incommensurable  thing.  It  is  neverthe- 
less a  real  thing,  and  is  especially  significant  as  constituting  one  of  the  differ- 
ences between  real  income  and  money  incomes. 

It  should  be  noted,  however,  that  consumers'  surplus  relates  only  to  one's 
consumption  of  a  particular  commodity,  taken  by  itself,  for,  as  we  have  seen, 
the  amount  which  we  are  willing  to  spend  in  the  purchase  of  any  one  com- 
modity depends  not  only  on  the  price  of  that  commodity,  but  also  on  the 
prices  of  the  other  commodities  that  make  up  our  purchases.  The  surpluses 
which  a  consumer  gets  in  his  different  lines  of  consumption  cannot  be 
added  together  to  form  a  total.  I  might,  for  example,  be  willing  to  pay 
as  much  as  four  dollars  for  a  hat  that  I  can  get  for  two  dollars.  And  if  I 
pay  only  two  dollars  for  the  hat  I  might  be  willing  to  pay  as  much  as  six 
dollars  for  a  pair  of  shoes  that  I  can  get  for  four  dollars.  But  it  does  not 
follow  that  I  should  be  willing  to  pay  four  dollars  for  the  hat  and  six  dollars 
for  the  shoes. 

The  Nature  of  Supply.  —  The  amount  of  goods  that  will  be 
supplied  in  a  given  market  at  a  given  time  depends,  like  the 
amount  demanded,  on  the  price.  "  Forced  sales,"  in  which 
goods  are  offered  for  whatever  can  be  got  for  them,  form  about 
the  only  important  exception.  The  effect  of  price  on  supply 
varies,  however,  according  to  the  length  of  time  that  is  taken 
into  consideration.  The  work  that  is  being  done  today  in  the 
extension  of  old  factories  and  the  building  of  new  ones,  the  con- 
struction of  railways,  the  taking  up  of  new  land,  is  based  on 
estimates  of  future  prices,  the  present  prices  of  agricultural  and 
manufactured  products  and  of  railway  transportation  being  of 
significance  only  so  far  as  they  indicate  what  future  prices  will 
be.  The  merchant's  stock  in  trade  is  bought  on  an  estimate  of 
future  business  conditions;  the  amount  of  land  the  farmer 
allots  to  wheat  and  corn,  respectively,  depends  on  his  estimate 
of  the  relative  prices  the  two  will  bring  after  the  harvest.     In  a 


VALUE  AND   PRICE 


163 


similar  way  the  amounts  of  goods  that  can  be  supplied  to  the 
market  today  are  limited  by  the  estimates  which  business  men 
and  farmers  have  made  in  the  past  of  the  prices  which  buyers 
are  willing  to  pay  today.  It  would  be  possible,  though  not 
necessary  for  our  purposes,  to  analyze  the  way  in  which  the 
amount  of  the  capital  and  labor  which  have  thus  been  applied 
to  the  production  of  things  that  will  satisfy  present  wants  was 
partially  determined  by  conditions  which  existed  still  farther 
back  in  the  past,  and  so  on  in  an  indefinitely  receding  series. 

The  amount  of  goods  available  for  the  market  of  today  is 
thus  determined  not  only  by  past  estimates  and  conditions,  but 
also  by  present  estimates  of  future  conditions.  Every  seller  has 
the  option  of  selling  at  the  present  price  or  of  waiting  for  possibly 
higher  future  prices  —  an  option  which  is  limited  only  by  the 
perishability  of  his  goods  and  the  urgency  of  his  need  for  money. 
And  the  most  urgent  need  for  money  does  not  necessarily  force 
an  immediate  sale  if  his  opinion  as  to  the  future  value  of  his 
goods  is  a  reasonable  one,  for  in  this  case  it  is  usually  easy  to 
borrow  money  on  the  strength  of  the  marketable  value  of  the 
goods. 

The  Supply  Curve.  —  In  the  analysis  of  the  conditions  of 
supply  existing  in  a  particular  market  at  a  particular  time  we 
do  not  have  to  take  account  of 
the  limitations  imposed  by  the 
forms  which  productive  efforts 
have  taken  in  the  past.  At 
any  given  time  a  certain  defi- 
nite amount  of  a  commodity  is 
available  for  the  market :  this 
forms  what  may  be  called  the 
potential  supply.  The  propor- 
tion of  this  potential  supply 
that  sellers  will  be  willing  to 
part  with  at  a  particular  time  will  depend  primarily  on  the  prices 
they  can  get.  If  the  price  of  a  unit  of  a  commodity  is  M' P' 
(Fig.  4),  the  sellers  will  be  willing  to  sell  a  certain  number  of 
units  of  it,  which  may  be  represented  by  OM'.     If  the  price  were 


164 


OUTLINES  OF  ECONOMICS 


as  low  as  PM,  however,  some  sellers  would  prefer  to  wait  foi 
higher  prices,  the  amount  thus  withheld  from  the  market  being 
represented  by  AIM'.  At  the  price  M"P",  however,  an  addi- 
tional supply  (M'M")  of  the  commodity  would  be  forthcoming 
from  sellers  who  were  not  tempted  by  the  price  M'P' .  In  gen- 
eral, the  supply  curve  SS'  represents  the  relations  between  price 
and  the  amount  that  will  be  supplied  in  a  particular  market 
and  at  a  particular  time. 

The  Determination  of  Price.  —  The  foregoing  discussion  of 
the  nature  of  demand  and  of  supply  makes  it  possible  to  ad- 
vance another  step  in 
our  analysis  of  the  de- 
termination of  price,  by 
asking  ourselves  what 
will  be  the  result  of  the 
simultaneous  operation 
of  the  forces  of  demand 
and  supply.  This  con- 
dition is  represented 
graphicallv  in  Figure  5, 
"  where  the  demand  curve 
and  supply  curve  are 
combined  in  one  diagram.  If  the  curve  DD'  represents  the 
potential  demand  in  a  particular  market  at  a  particular  time, 
and  the  curve  SS'  represents  the  potential  supply,  the  price 
which  would  be  fixed  by  the  free  working  of  competitive  forces 
would  be  PM,  located  at  the  point  where  the  two  curves  cross. 
At  this  point  demand  and  supply  are  equal,  both  being  rep- 
resented by  OM.  It  is  impossible  that  the  price  should  be 
fixed  at  any  other  point,  M'P' ,  for  example.  For  if  M"Q  be 
drawn  so  as  to  equal  M'P',  it  will  be  evident  that  at  this  price 
OM"  units  will  be  demanded,  while  only  OM'  units  will  be  sup- 
plied. Most  of  the  buyers,  however,  are  willing  to  pay  more 
than  M'P'  if  necessary,  so  that  in  order  to  secure  their  share 
they  will  bid  the  price  up  until  an  equilibrium  is  reached. 
This  is  what  John  Stuart  Mill  meant  w'^en  he  said  that  "  value 
always  adjusts  itself  in  such  a  mannei  that  the  demand  is  equal 


VALUE  AND   PRICE  1 65 

to  the  supply,"  —  a  statement  which  has  often  been  misinter- 
preted, and  consequently  unjustifiably  criticized. 

The  prices  for  which  goods  are  sold  in  a  competitive  market 
are  thus  the  outcome  or  resultant  of  the  individual  valuations  of 
all  who  buy  and  sell  in  the  market.  Each  buyer  or  seller, 
taken  by  himself,  affects  only  inappreciably  the  price  at  which 
he  buys  or  sells.  All  that  he  can  do  is  to  buy  or  sell  or  refuse 
to  buy  or  sell,  or  to  buy  or  sell  more  or  less.  For  each  individual 
trader  the  market  price  is  something  beyond  his  own  control. 
And  yet  each  has  a  part  in  that  collective  supply  and  demand 
which  is  the  controlling  factor  in  making  the  price  whatever  it 
happens  to  be. 

Producers'  Surplus.  —  Just  as  the  area  APT)  (Fig.  5)  has  sometimes  been 
considered,  not  altogether  accurately,  to  represent  a  "Consumers'  Surplus" 
(of  utility  over  costs),  so  the  area  APS  has  been  considered  to  correspond  to 
what  has  been  called  "Producers'  Suipius"  or  "Sellers'  Gains."  This  sur- 
plus should  not  be  thought  of  as  corresponding  to  the  actual  profits  of  the 
sellers;  that  is,  as  being  in  any  way  a  surplus  of  receipts  over  and  above  the 
expenses  cf  production.  That  part  of  the  supply  which  had  been  produced 
at  the  smallest  expense  is  not  necessarily  the  part  which  its  owners  would 
be  willing  to  sell  at  the  lowest  price.  It  cannot  be  too  strongly  emphasized 
that  the  analysis  of  demand  and  supply  thus  far  presented  relates  only  to 
the  conditions  existing  in  a  particular  market  at  a  particular  time.  All  that 
we  can  say  is  that  when  OM  units  are  sold  at  the  price  of  MP  per  unit,  the 
total  receipts  of  the  sellers  are  represented  by  the  rectangle  OM  PA  ;  while 
the  area  OMPS  represents  what  they  would  have  been  willing  to  sell  the 
same  amount  of  goods  for,  had  they  not  been  able  to  get  a  larger  return. 
There  is,  as  we  shall  see,  a  relation  between  the  prices  of  things  and  the  ex- 
pense of  producing  them,  when  a  considerable  period  of  time  is  taken  into 
consideration.  At  any  given  time,  however,  sellers  are  mainly  governed 
by  the  relative  profitableness  of  selling  at  existing  prices  or  waiting  for 
higher  ones.  The  only  kind  of  surplus  which  the  area  APS  represents  is 
an  intangible,  hypothetical  thing,  —  the  difference  between  actual  receipts 
and  the  amount  which  would  have  been  received  if  each  seller  had  sold  each 
portion  of  his  supply  for  the  minimum  price  he  would  have  been  willing  to 
take  for  that  portion. 

QUESTIONS 

1.  Is  there  such  a  thing  as  "intrinsic  value"?  What  is  usually  meant 
when  the  expression  is  used? 

2.  How  can  one  buy  more  or  less  of  a  non-divisible  good,  like  a  house? 


1 66  OUTLINES   OF  ECONOMICS 

3.  Does  the  tendency  of  each  individual  to  maintain  the  equilibrium  of 
his  margin  of  consumption  result  in  the  maximum  satisfaction  of  his  wants  ? 

4.  What  relation  is  there  between  the  amounts  which  a  college  student 
pays  for  room  rent,  for  food,  for  clothing,  for  books,  and  for  athletics  ? 

5.  Which  of  your  customary  purchases  would  you  still  make  if  prices 
were  doubled?    Which  would  you  curtail?    Which  would  you  omit? 

6.  Illustrate  the  propositions  relating  to  elasticity  of  demand  (p.  160)  by 
concrete  examples. 

7.  Construct  an  imaginary  demand  "schedule,"  showing  in  parallel 
columns  (1)  six  or  eight  different  possible  prices  of  wood  per  cord,  and  (2) 
the  number  of  cords  which  an  imaginary  purchaser  would  buy  at  each  stated 
price.  Construct  in  the  same  way  other  demand  schedules  for  each  of  four 
other  possible  purchasers.  Combine  these  five  individual  demand  schedules 
into  a  collective  demand  schedule  showing  the  total  amount  of  wood  that 
could  be  sold  at  each  price.  Construct  in  a  similar  way  individual  supply 
schedules  and  a  collective  supply  schedule  for  four  sellers  of  wood.  Assum- 
ing that  all  the  wood  sold  is  sold  at  a  uniform  price,  how  much  wood  will 
be  sold  and  at  what  price  ? 

8.  "For  some  years  the  supply  of  Brazilian  coffee  was  greater  than 
the  demand  for  it."     Criticize  and  amend  this  statement. 

REFERENCES 

Bohm-Bawerk,  E.  von.     Positive  Theory  of  Capital,  Book  iv,  Chaps,  i-vi. 

Carver,  T.  N.     Distribution  of  Wealth,  Chap.  i. 

Cunyghame,  Henry.     Geometrical  Political  Economy,  Chaps,  iii  and  iv. 

Davenport,  H.  J.    Economics  of  Enterprise,  Chaps,  v-vii. 

Fetter,  F.  A.     Economic  Principles,  Part  i. 

Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Book  iii  and  Book 

v,  Chaps,  i  and  ii. 
Mill,  J.  S.    Principles  of  Political  Economy,  Book  iii,  Chaps  i  and  ii. 
Taussig,  F.  W.    Principles  of  Economics,  Vol.  i,  Chaps  viii-x. 
Wieser,  F.  voh.    Natural  Value,  Book  ii,  Chaps  i-v. 


CHAPTER  XI 
VALUE   AND    PRICE    {Continued) 

Some  of  the  most  important  factors  in  the  determination  of 
exchange  values  are  not  revealed  by  an  analysis  of  the  conditions 
of  supply  and  demand  which  happen  to  exist  at  a  particular 
time.  In  the  preceding  chapter  we  assumed  the  existence 
of  a  certain  potential  demand  and  a  certain  potential  supply, 
and  explained  how  these  result  in  the  equilibrium  of  actual  de- 
mand and  supply  at  a  certain  price.  Our  next  task  is  to 
inquire  into  the  influences  which  determine  potential  demand 
and  potential  supply.  For  this  purpose  we  shall  need  to  pass 
from  the  study  of  the  way  in  which  the  preferences  and  choices 
of  individual  buyers  and  sellers  react  upon  and  fix  the  par- 
ticular market  price  which  exists  at  any  one  time  to  an  inquiry 
into  the  operation  of  certain  slowly  acting  movements  and 
tendencies. 

The  demand  side  of  this  problem  need  not  detain  us.  De- 
mand will  change  with  changes  in  incomes,  tastes,  fashions, 
and  the  like.  The  effect  of  these  influences  is  so  obvious  that 
it  may  be  taken  for  granted.  The  supply  side  of  the  problem, 
however,  needs  further  study.  The  potential  supply  of  the 
present  is  limited  by  conditions  set  by  past  industry.  The 
amounts  of  different  kinds  of  consumption  goods  that  are 
ready  for  present  use  depend  upon  the  direction  which  the 
work  of  production  has  taken  in  the  past.  What,  in  the  long 
tun,  is  the  relation  between  supply  and  exchange  value? 

Prices  and  the  Expenses  of  Production. — The  dominant 
motive  that  guides  farmers  and  business  men  in  their  invest- 
ments of  labor  and  capital  is  the  desire  for  money  profits.  (By 
profits  we  here  mean  the  difference  between  the  expense  in- 
volved in  producing  goods  and  the  money  that  is  obtained  for 
them.)     If  it  were  always  an  easy  matter  for  business  men  to 

167 


1 68  OUTLINES  OF  TCONOMICS 

change  their  interests  and  their  energies  from  one  line  of  pro- 
duction to  another,  and  if  capital  and  labor  could  likewise  be 
freely  transferred  from  one  undertaking  to  another,  it  is  hard 
to  see  how  profits  in  any  one  competitive  industry  could  be  for 
any  length  of  time  much  higher  than  in  other  competitive 
industries.  Managerial  ability,  labor,  and  capital  would  gravi- 
tate always  toward  those  employments  which  promise  the 
greatest  profits.  The  effect  would  be  a  continual  movement 
toward  equality  of  advantage  in  different  fields  of  industry. 
This  does  not  necessarily  mean  an  equality  of  profits  as  between 
individuals  in  any  given  line  of  business,  for  the  amount  of 
profits  depends  largely  upon  the  ability  and  enterprise  of  the 
individual  business  man.  But  in  a  state  of  free  competition, 
with  alternative  business  opportunities  as  free  and  open  as  we 
have  assumed,  the  profits  of  any  business  undertaking  would 
hardly  be  larger,  for  any  period  of  time,  than  the  business  man 
could  get  as  salary  by  working  for  others,  —  for  if  working  for 
others  offered  a  greater  return  than  assuming  the  risks  of  busi- 
ness for  himself,  he  would  naturally  choose  the  salaried  position, 
and  vice  versa.  Purely  competitive  profits,  under  conditions  of 
this  absolute  "  fluidity  "  of  business  ability,  of  labor,  and  of 
capital,  would  thus  tend  to  adjust  themselves  according  to  the 
ability  of  the  individual  business  man;  that  is,  to  equal  what 
we  shall  later  describe  as  the  "  wages  of  management."  If  we 
include  the  value  of  the  business  man's  services,  thus  measured, 
among  the  expenses  of  production,  we  may,  obviously,  state 
the  tendency  which  we  have  described  as  a  tendency  toward  the 
equality  of  the  prices  received  for  the  products  of  any  particular 
industry  and  the  expenses  of  producing  them. 

The  assumptions  we  have  made  do  not,  however,  exactly  cor- 
respond to  the  conditions  of  actual  business.  Managerial 
ability,  labor,  and  capital  are  all  specialized  to  a  greater  or  less 
extent,  so  that  they  cannot  be  changed  from  one  employment 
to  another  without  loss  of  efficiency.  But  it  is  not  necessary 
for  the  validity  of  our  analysis  that  all  managerial  ability,  all 
labor,  and  all  capital  should  be  fluid  enough  to  change  from 
industry  to  industry  economically.     There  are  always  many 


VALUE  AND   PRICE  1 69 

business  men  who  are  anxiously  watching  for  the  most  inviting 
business  opportunities;  there  is  always  a  certain  amount  of 
labor  awaiting  the  most  remunerative  employment,  and  there 
is  always  a  certain  amount  of  money  awaiting  investment  in 
those  forms  of  capital  goods  which  promise  the  greatest  return. 
These  facts  are  enough  to  give  substantial  truth  to  the  state- 
ment that  in  any  competitive  industry  the  price  of  the  com- 
modity produced  tends  to  equal  the  cost  of  producing  it.  When 
the  price  of  bicycles  was  high,  as  compared  with  the  expense  of 
producing  them,  existing  bicycle  factories  wrere  extended  and 
new  ones  were  built.  The  supply  of  bicycles  was  thus  so 
increased  that  they  could  not  be  sold  except  at  a  much  lower 
price.  On  this  account  and  because  of  the  cessation  of  demand, 
the  profits  in  the  manufacture  of  bicycles  became  relatively 
low,  and  many  former  bicycle  factories  are  now  used  for  other 
purposes.  If  the  excess  of  the  price  of  wheat  over  the  expense 
of  producing  it  promises  to  be  greater  than  the  excess  of  the 
price  of  corn  over  the  expense  of  producing  it,  farmers  will 
raise  less  corn  and  more  wheat,  and  the  result  will  be  higher 
prices  for  corn  and  lower  prices  for  wheat. 

Normal  Price.  —  Because  the  market  price  of  a  commodity 
cannot  get  very  far  away  from  the  expense  of  producing  it 
without  resulting  in  abnormally  high  or  abnormally  low  profits, 
and  because  the  existence  of  abnormally  high  or  abnormally  low 
profits  sets  forces  at  work  which  are  very  sure  to  move  the  price 
closer  to  the  expense  of  production,  the  name  normal  price  is 
given  to  that  price  which  is  just  equal  to  the  expense  of  producing 
a  unit  of  a  commodity. 

The  effectiveness  of  the  tendency  of  actual  competitive  prices 
to  equal  normal  prices  depends  very  largely  upon  the  length 
of  the  period  of  time  that  is  taken  into  consideration.  The 
longer  the  period  of  time,  the  larger  will  be  the  proportion  of 
managerial  ability,  labor,  and  capital  that  can  be  shifted  from 
the  less  profitable  to  the  more  profitable  undertakings.  To 
build  and  to  equip  new  factories  and  to  extend  old  ones  takes 
time ;  the  supply  of  skilled  labor  in  any  occupation  can  often 
be  increased  but  slowly,  for  many  trades  involve  an  appren» 


170  OUTLINES  OF  ECONOMICS 

ticeship  of  three  or  more  years.  In  the  undertakings  that  are 
becoming  less  profitable,  although  capital  specialized  in  the 
form  of  machines  may  not  be  useful  for  other  purposes,  yet  such 
machines  need  not  be  replaced  as  they  wear  out ;  while  a  skilled 
laborer  cannot  take  up  another  trade  without  loss  of  efficiency, 
yet  an  increasing  proportion  of  the  incoming  supply  of  laborers 
may  begin  their  apprenticeship  in  those  occupations  in  which 
there  is  a  greater  demand  for  labor. 

While  the  conditions  of  long-period  supply  are  thus  such  as 
to  result  in  a  constant  movement  toward  the  equalization  of 
market  price  and  normal  price,  it  may  easily  happen  that  the 
two  will  never  become  identical.  For  market  prices  them- 
selves are  constantly  changing  under  the  influence  of  changing 
demand.  And  the  increase  in  the  output  of  an  especially  profit- 
able product  is  often  overdone.  Periods  of  losses  or  of  low 
profits  may  succeed  periods  of  high  profits.  In  short,  the  goal 
toward  which  business  enterprise  directs  productive  efforts  is 
constantly  shifting. 

Different  Conditions  of  Supply.  —  A  fact  of  prime  im- 
portance is  that  the  expense  of  production  {per  unit)  often  varies 
as  the  amount  produced  is  larger  or  smaller.  But  this  relation 
between  the  amount  of  goods  produced  and  the  expense  of 
producing  them  is  different  for  different  industries.  In  partic- 
ular, three  forms  of  productive  undertaking  may  here  be  dis- 
tinguished :  those  in  which  increased  production  is  accompanied, 
in  the  long  run,  with  (i)  increasing,  (2)  decreasing,  or  (3)  con- 
stant expense  per  unit  of  product. 

1.  If  transportation  facilities,  the  knowledge  of  agricultural 
methods,  and  other  controlling  conditions  remain  unchanged, 
the  amount  of  wheat  raised  in  the  United  States  cannot  be  sub- 
stantially increased  without  resort  to  lands  less  well  adapted 
to  the  production  of  wheat,  or  the  more  intensive  cultivation  of 
lands  already  in  use.  Either  alternative  requires  (as  will  be 
shown  in  a  later  chapter  in  more  detail)  the  use  of  relatively 
more  labor  and  capital  per  bushel  in  producing  the  additional 
wheat  than  was  required  for  the  wheat  produced  under  the  for- 
mer conditions.     This  means  that  the  production  of  wheat 


VALUE  AND   PRICE  171 

cannot  be  substantially  increased  except  at  an  increased  ex- 
pense per  bushel.  When  this  condition  of  increasing  expense  is 
met  with  —  and  it  holds  true  generally  in  agriculture  —  normal 
price  increases  with  an  increase  in  production.  If  the  price 
of  the  product  is  not  high  enough  to  repay  the  cultivation  of  the 
poorest  lands  used,  they  will  cease  to  be  cultivated.  If  the 
price  of  the  product  is  appreciably  higher  than  the  expenses  of 
cultivation,  farmers  will  find  it  profitable  to  push  cultivation 
still  farther,  up  to  the  point  where  the  expense  equals  the  price. 
2.  In  some  industries,  however,  an  increase  in  production 
will  often  bring  forces  into  operation  that  will  result  in  smaller 
expenses  of  production  per  unit  of  product.  Where  this  condi- 
tion of  decreasing  expense  is  found,  a  general  increase  in  produc- 
tion brings,  in  the  long  run,  a  decrease  in  the  normal  price  of 
the  product.  What  is  the  nature  of  these  economies  that  some- 
times attend  an  increase  of  production?  We  rule  out  of  con- 
sideration such  things  as  new  inventions  and  the  general  prog- 
ress of  industrial  knowledge  and  technique,  for  although  these 
things  reduce  the  expenses  of  production,  they  are  in  no  direct 
way  a  necessary  result  of  an  increasing  output.  They  play 
a  part,  moreover,  in  agriculture  (where  they  help  to  counteract 
the  effects  of  the  rule  of  increasing  expenses)  as  well  as  in  in- 
dustries of  decreasing  expenses.  Additions  to  our  knowledge 
of  ways  of  producing  things  are  undoubtedly  stimulated  by  the 
growth  of  production,  which  gives  increased  scope  and  impor- 
tance to  improvements  in  industrial  technique ;  but  for  the 
purposes  of  the  present  inquiry  we  must  put  these  things  aside 
and  merely  assume  a  given  state  of  industrial  knowledge.  The 
economies  that  create  the  condition  of  decreasing  expenses  are, 
properly  understood,  only  such  as  are  brought  about,  in  a 
fairly  direct  way,  by  the  increase  of  production  itself.  Here  we 
must  distinguish  two  things :  first,  economies  in  the  general 
organization  of  whole  industry,,  and,  second,  economies  result- 
ing from  an  increase  in  the  size  of  the  individual  business 
establishments  within  the  industry.1 

1  These  are  named   by  Professor  Alfred   Marshall  "external  economies"  and 
"internal  economies." 


172  OUTLINES  OF  ECONOMICS 

The  most  important  of  the  first  of  these  two  classes  of  econo- 
mies is  a  greater  specialization  or  division  of  labor  within  the 
industry.  The  different  processes  in  the  operations  of  the  in- 
dustry may  be  separated  and  apportioned  to  different  specialized 
plants,  located,  perhaps,  at  particularly  advantageous  points. 
Opportunity  is  given  for  a  more  thoroughgoing  and  more 
efficient  specialization  of  labor  and  for  the  use  of  highly  special 
ized  machinery.  Subordinate  industries  may  be  developed, 
supplying  machinery  and  other  equipment ;  improved  trans- 
portation facilities  of  one  kind  and  another  may  be  secured.  It 
becomes,  in  general,  more  feasible  for  the  industry  to  utilize 
what  are  known  to  be  the  best  and  most  economical  methods  of 
production  and  to  keep  pace  with  the  advance  of  technical 
knowledge.  Indirect,  roundabout  ways  of  doing  things,  involv- 
ing a  thoroughgoing  subdivision  of  processes  and  the  use  of 
large  amounts  of  fixed  capital  in  the  form  of  elaborate  plants 
and  expensive  machinery  are  advantageous  only  when  the 
industrial  output  is  large.  All  these  things  have  played  an 
important  part  in  the  progress  of  most  of  the  great  manufac- 
turing industries,  and  in  making  their  products  cheaper. 

Unless  some  obstacle,  some  countervailing  force,  prevents, 
these  economies  are  sufficient  to  make  almost  any  large  and 
growing  industry  one  of  decreasing  expenses.  And  about  the 
only  obstacle  that  can  stand  in  the  way  is  the  limitation  of 
the  supply  of  one  of  the  necessary  factors  in  production.  The 
supply  of  capital  has  (as  shown  by  the  interest  rate)  kept  pace 
with  industrial  demands.  The  industrial  output  has  increased 
more  rapidly  than  has  the  supply  of  labor,  but  in  most  industries 
this  has  not  been  sufficient  to  offset  the  movement  toward 
decreasing  expenses.  But  the  supply  of  land  and  of  natural 
products  of  various  kinds  is  definitely  limited.  This  is  why 
agriculture,  despite  the  fact  that  it  benefits  by  some  of  the 
economies  of  specialization,  is  not  an  industry  of  decreasing 
expenses.  For  the  same  reason  the  lumber  industry  and  petro- 
leum industry  have  had  to  contend,  in  recent  years,  with  in- 
creasing expenses. 

The  second  class  of  economies  —  those  connected  with  the 


VALUE  AND   PRICE  1 73 

increasing  size  of  the  individual  business  unit  —  are  usually 
named  "  the  economies  of  large-scale  production."  These  are 
of  interest  to  us  at  the  present  stage  of  our  study  only  in  so  far 
as  large-scale  production  is  in  itself  a  result  of  the  general  growth 
in  the  volume  of  the  output  of  an  industry.  Other  things,  such 
as  the  invention  of  new  and  effective  "  large-scale  "  methods  of 
production  and  the  cheapening  of  transportation  (broadening 
the  market  open  to  a  particular  plant),  have  cooperated  in 
stimulating  the  growth  of  large  establishments.  Our  present 
inquiry  is  merely  into  the  relation  between  the  increase  in  the 
total  amount  of  goods  produced  and  the  expense  of  producing 
them ;  that  is,  into  the  long-run  relation  between  supply  and 
normal  price.  And  so  our  question  is:  Does  a  larger  output 
for  an  industry  at  large  encourage  the  growth  of  large  individual 
establishments  by  increasing  any  advantages  they  may  have 
over  smaller  establishments?  It  is  clear  that  there  is  no  in- 
variable rule  here,  for  in  agriculture  and  in  some  special  fields 
of  manufactures  and  trade  the  average  size  of  the  individual 
undertaking  is  not  increasing,  despite  the  rapid  growth  of  the 
total  volume  of  output.  But  in  nearly  all  the  industries  in 
which  we  have  any  reason  to  suspect  the  presence  of  the  rule  o^ 
decreasing  expenses  we  find  that  the  average  establishment  has 
been  growing  larger.  This  must  mean  that  in  many  industries 
the  first  class  of  economies,  already  described,  can  best  be  util- 
ized by  relatively  large  establishments. 

Whatever  the  real  "  economies  of  large-scale  production  " 
may  be  (and  they  will  be  discussed  in  the  following  chapter), 
they  cannot  in  themselves  be  adequate  to  bring  about,  in  any 
competitive  industry,  the  general  condition  of  decreasing  ex- 
penses. Wherever  the  advantages  of  large-scale  production 
are  increasing,  the  principal  effect  must  be  merely  to  divide  the 
aggregate  operations  of  the  industry  among  a  somewhat  smaller 
number  of  establishments  than  would  otherwise  be  found.  But 
the  growth  of  the  size  of  the  business  establishment  has  no  direct 
bearing  upon  the  existence  of  the  condition  of  decreasing  ex- 
penses in  the  industry  at  large,  except  in  so  far  as  an  increase 
in  the  size  of  the  individual  establishment  is  found  to  be  one 


i74 


OUTLINES   OF  ECONOMICS 


of  the  ways  of  utilizing  to  best  advantage  the  various  economies 
made  possible  by  the  increased  industrial  product.  Large- 
scale  production  does  not  create  the  condition  of  decreasing 
expenses,  but  it  may  be  an  indication,  a  manifestation  of  the 
presence  of  that  condition.1 

3.  In  many  hand  industries,  such  as  tailoring  and  cigar 
making,  the  expense  of  production  per  unit  does  not  vary  to  any 
great  extent  with  the  amount  produced.  These  are,  therefore, 
industries  with  constant  expenses. 

Figures  1,2,  and  3  illustrate  the  relation  of  changes  in  supply 
to  changes  in  price  under  the  conditions  of  increasing,  decreas- 
ing, and  constant  expenses,  re- 
spectively. These  diagrams 
must  be  carefully  distinguished 
from  the  supply  curve  described 
in  the  preceding  chapter,  which 
related  only  to  the  conditions 
of  supply  at  a  particular  time. 
They  indicate  the  way  in  which 
an  increased  output,  evoked  by 
an  increase  in  demand,  will,  in 
the  long  run,  be  offered  to  the 
market  at  higher,  lower,  or  constant  prices,  depending  upon  the 
conditions  existing  in  different  classes  of  industries.  In  an  in- 
dustry of  decreasing  expenses  (Figure  2),  for  example,  OM 
units  of  product  per  year  cannot  be  supplied  to  the  market  at 
a  lower  price  per  unit  than  PM.  But,  allowing  time  for  the 
necessary  reorganization  of  the  industry,  OM'  units  per  annum 
can  be  supplied  at  a  lower  price,  P'M'.  In  an  industry  of  in- 
creasing expenses  this  relation  between  price  and  amount  of 
output  is  reversed. 

Fixed  and  Variable  Expenses.  —  There  is  no  better  illustra- 

1  Wc  have  thought  it  worth  while  to  emphasize  the  merely  indirect  relation  be- 
tween the  economies  of  large-scale  production  and  the  so-called  "law"  of  decreasing 
expenses  (or  "increasing  returns"),  because  there  is  much  confusion  of  thought  on 
I  his  matter.  Only  when  an  industry  is  controlled  by  a  monopoly,  are  the  real  econo- 
mi  s  of  a  large  industrial  output  identical  with  the  "economies  of  large-scale  pro- 
dui  tion." 


Fig. 


VALUE  AND   PRICE 


175 


Fig. 


tion  of  the  necessity  of  keeping  definite  periods  of  time  in  mind 
when  discussing  problems  relating  to  valuation  than  that 
furnished  by  the  problem  of  the  apportionment  of  specific 
expenses  of  production  to  par-  y 
ticular  units  of  products.  In 
almost -any  industrial  establish- 
ment, any  increase  in  product 
will  be  attended  by  some  specific 
increase  in  expenses:  more  raw 
material  and  more  labor  will  be 
used,  possibly  more  power; 
although  the  increased  expenses 
for  labor  and  power  may  not 
be  proportionate  to  the  increase 
in  production.  Such  expenses  are  called  variable  expenses,  and 
are  to  be  contrasted  with  fixed  expenses,  which  remain  approx- 
imately the  same,  no  matter  what  the  amount  produced  is. 
The  interest  on  the  funds  invested  in  the  factory  building 
and  its  equipment  of  machinery  is  a  fixed  expense ;  the  expense 
of  management  and  general  office  expenses  will  not  usually 
be  increased  proportionately  by  an  increase  in  the  annual 
product  of  an  establishment. 

It  is  often  assumed  that  wherever  only  a  part  of  the  expenses 

varies  with  the  amount  pro- 
duced, the  establishment  is 
ipso  facto  one  in  which  large- 
scale  production  is  especially 
economical.  Whether  this  as- 
sumption holds  true  or  not 
often  depends  on  the  scale  of 
production  we  have  in  mind. 
Factories  and  other  plants  are 
built  with  a  certain  maximum 
capacity,  and  until  that  maxi- 
mum capacity  is  utilized,  production  may  be  increased  without  a 
proportionate  increase  in  expenditure.  But  when  the  maxi- 
mum is  reached,  more  equipment,  and  often  more  buildings,  will 


176 


OUTLINES   OF   ECONOMICS 


r» 


be  needed  before  there  can  be  a  further  increase  in  product 
There  is  often  a  certain  most  efficient  size  of  plant ;  an  increase 
in  business  beyond  the  capacity  of  the  most  efficient  size  of  plant 
necessitates  either  a  curtailing  of  the  business  or  a  duplication 
of  the  plant.  When  business  conditions  are  such  as  to  warrant 
temporarily  pushing  the  output  of  a  plant  beyond  its  normal 
capacity,  the  result  usually  is,  as  every  manufacturer  knows, 
that  this  increased  output  is  produced  uneconomically,  that  is, 
at  relatively  increased  expenses  of  production. 

Many  seemingly  constant  expenditures  (like  interest  on  the 
cost  of  the  plant)  are  variable  in  the  long  run.  Such  expendi- 
tures increase,  but  only  at  considerable  intervals  of  time,  as 

additional  invest- 
ments in  fixed  cap- 
ital are  made.  A 
long-period  supply 
curve  correspond- 
ing to  the  condi- 
tions of  production 
in  such  a  business 
might  be  some- 
thing like  Figure 
—  y  4.  This  diagram 
should  be  inter- 
preted as  follows: 
The  total  expense  of  producing  a  certain  output,  OM,  is  repre- 
sented by  the  area  OMPS.  MP  (considered  not  as  a  mere  line, 
but  as  an  indefinitely  narrow  area)  represents  the  variable  ex- 
pense which  would  not  be  incurred  if  the  volume  of  production 
were  a  little  smaller  than  OM  units.  MP,  then,  represents  the 
marginal  expense,  in  this  particular  establishment,  of  producing 
OM  units.  Thus  the  irregular  curve  SS'  represents  the  way  in 
which  the  aggregate  expenses  of  production  are  increased  as  the 
output  (measured  on  the  line  OX)  grows.  When  the  product 
reaches  OM'  units,  and  again  when  it  reaches  OM"  units, 
fresh  investments  of  large  amounts  of  capital  are  necessary. 
From  the  long-time  point  of  view,  such  a  business  might  very 


if 


M' 


M 
Fig.  4 


VALUE   AND   PRICE  177 

possibly  be  one  of  approximately  constant  expenses ;  although 
of  course  some  of  the  real  economies  of  large-scale  production 
might  be  present  and  might  result  in  decreasing  expenses. 

The  Relation  of  Fixed  and  Variable  Expenses  to  Price.  —  The 
fact  that,  within  limits,  the  expenses  of  a  business  undertaking 
do  not  increase  proportionately  as  the  output  increases  has  an 
important  bearing  upon  competitive  price-making.  The  pro- 
prietors of  a  business  establishment  will  feel  justified  in  in- 
creasing their  output,  provided  the  additional  output  will  sell 
for  enough  to  afford  some  profit  above  the  actual  amount  by 
which  it  increases  their  expenses.  If  the  full  capacity  of  their 
plant  is  not  already  utilized,  they  will  count  as  profit  any  addi- 
tional income  they  can  secure  above  the  necessary  increase  in 
variable  expenses.  If  they  are  producing  some  staple  commod- 
ity for  the  general  market,  so  that  they  cannot  discriminate 
in  the  prices  at  which  they  sell  to  different  buyers,  they  will 
find  it  difficult  to  make  much  use  of  this  possibility  of  cutting 
prices  on  part  of  their  output.  But  if  they  are  producing  a 
variety  of  goods,  if  they  are  making  highly  specialized  products 
"  to  order,"  or  if  they  are  selling  in  two  or  more  widely  separated 
markets,  they  may  often  be  able  to  increase  their  output  by 
accepting  prices  too  low  to  contribute  anything  to  the  payment 
of  their  fixed  expenses.  This  is  often  the  explanation  of  the 
"  dumping  "  of  part  of  a  manufacturer's  product  on  a  foreign 
market  at  a  lower  price  than  he  charges  at  home.  Railways  are 
able  to  take  advantage  of  the  fact  that  (for  the  time  being) 
only  part  of  their  expenses  vary  with  their  traffic,  for  they  do 
not  have  to  charge  a  uniform  rate  per  ton  per  mile,  but  can 
classify  their  rates  according  to  the  origin,  destination,  and 
nature  of  the  traffic.  The  rates  charged  by  electric  plants  are 
often  less  for  current  used  at  certain  hours  of  the  day  when  the 
capacity  of  the  plant  is  only  partly  utilized.  The  reader  will 
probably  be  able  to  supplement  these  illustrations  with  others 
based  upon  his  own  observation. 

If  a  business  establishment  is  hard  pressed  by  competition, 
or  if  for  any  other  cause,  such  as  a  dull  season,  its  sales  are 
small,  its  proprietors  may  decide  to  cut  prices  on  their  whole  out- 


178  OUTLINES  OF   ECONOMICS 

put  to  a  point  that  will  cover  the  variable  expenses  and  possibly 
contribute  something  toward  meeting  the  fixed  expenses.  Some 
fixed  charges,  like  depreciation,  interest,  rent,  insurance,  taxes, 
will  continue  even  if  the  output  is  little  or  nothing.  It  will  very 
likely  be  sound  business  policy  to  make  the  best  of  a  bad  situa- 
tion by  getting  what  little  income  can  be  had  over  and  above 
the  variable  expenses  of  production.  Much  money  may  have 
been  irrevocably  invested  in  the  business,  and  although  possibly 
under  no  conditions  can  it  be  made  to  yield  the  return  that  had 
been  expected  at  the  time  when  the  investment  was  made, 
matters  will  not  be  bettered  by  letting  the  plant  lie  idle.  It  may 
be  that  the  prices  which  the  proprietors  of  the  business  thus 
reluctantly  decide  to  accept  are  high  enough  to  pay  all  the  ex- 
penses of  production,  fixed  and  variable,  in  some  competing 
plants,  better  organized  or  more  favorably  located.  Or  it 
may  be  that  some  or  all  of  the  competing  plants  also  find  it 
necessary  to  accept  prices  that  do  not  cover  their  fixed  expenses. 
Sometimes  the  fact  that  it  is  more  profitable  to  produce  at 
prices  which  cover  merely  the  variable  expenses  than  not  to 
produce  at  all  leads  some  one  establishment  to  cut  prices.  Other 
establishments  have  to  reduce  prices  in  order  to  protect  them- 
selves, and  a  period  of  cut-throat  competition  may  ensue. 

Though  at  any  given  time  it  may  be  the  variable  rather  than 
the  aggregate  expenses  of  production  per  unit  of  product  which 
fix  the  price  at  which  some  or  all  of  the  different  establish- 
ments in  an  industry  are  selling  their  products,  it  should  not  be 
inferred  that  it  is  the  variable  expenses  alone  which  measure 
the  normal  price  of  a  product.  For  in  the  long  run  prices  have 
to  be  high  enough  to  induce  the  replacement  of  fixed  capital  as 
it  wears  out  and  (in  a  growing  industry)  to  attract  new  perma- 
nent investments  of  capital.  That  is,  in  the  long  run,  prices 
have  to  be  high  enough  to  cover  both  variable  expenses  and 
fixed  expenses,  —  which  last,  as  we  have  seen,  are  generally 
variable  as  seen  through  a  sufficiently  long  period  of  time.  As 
a  matter  of  fact,  the  prices  in  any  large  competitive  industry 
are  usually  high  enough  to  more  than  cover  the  expenses  of 
production  in  the  most  efficient  establishments,  but  are  rarely 


VALUE   AND   PRICE  1 79 

high  enough  to  cover  all  such  expenses  in  the  least  efficient 
establishments.  For  the  time  being  the  weaker  establishments 
may  continue  in  operation,  but  sooner  or  later  they  are  sure 
to  be  forced  out.  The  better  establishments  will  be  enlarged, 
and  new  and  possibly  yet  more  efficient  ones  will  be  built.  If, 
however,  none  of  the  establishments  in  an  industry  is  able  to 
cover  all  of  its  expenses,  the  volume  of  output  must  eventually 
decline  to  a  point  where  prices  can  be  secured  that  will  cover 
interest,  depreciation,  and  the  other  fixed  expenses  that  must  be 
provided  for  if  the  recurrent  needs  of  the  industry  for  fresh 
investments  in  fixed  capital  are  to  be  met.  It  is  in  these  ways 
that  the  tendency  of  prices  to  equal  the  expenses  of  production 
manifests  itself. 

Joint  Expenses  of  Production.  —  When  the  production  of  one 
commodity  is  inevitably  accompanied  by  the  production  of  one 
or  more  other  commodities,  it  is  often  impossible  t®  assign  a 
definite  part  of  the  total  expense  of  production  to  any  one  of 
the  commodities.  It  is  impossible  to  separate  the  expenses  of 
producing  tenderloin  steaks  from  the  expenses  of  producing 
soup  bones,  or  either  one  of  these  from  the  expenses  of  producing 
hides.  Mutton  and  wool,  cotton  and  cotton  seed,  coal  gas  and 
coke,  are  familiar  examples  of  commodities  produced  under 
conditions  of  joint  expense.  Modern  methods  for  the  utiliza- 
tion of  industrial  by-products  have  greatly  increased  the  list  of 
commodities  produced  under  such  conditions. 

What  is  the  normal  price  of  these  jointly -produced  commod- 
ities? Take  first  the  simplest  case:  that  in  which  all  the 
expenses  of  producing  two  commodities  are  joint  expenses- 
Neither  commodity  can  be  said  to  have  a  normal  price  of  its 
own,  for  neither  commodity  has  specifically  assignable  expenses 
of  production  of  its  own.  But  the  two  commodities,  taken 
together,  have  what  may  be  called  a  collective  normal  price. 
Suppose,  for  example,  that  the  production  of  every  unit  of  one 
commodity  is  necessarily  accompanied  by  the  production  of 
two  units  of  the  other  commodity.  It  is  evident  that  in  order 
to  induce  the  production  of  these  commodities  the  price  of  a  unit 
of  the  first  commodity  plus  the  price  of  two  units  of  the  second 


180  OUTLINES  OF  ECONOMICS 

commodity  must  cover  the  joint  expense  of  producing  these 
three  units.  This  joint  expense,  then,  measures  the  collective 
normal  price  of  the  three  units.  Just  how  the  market  prices 
which,  in  their  sum,  will  tend  to  approximate  this  collective 
normal  price,  will  be  fixed,  will  depend  upon  the  conditions  of 
demand  for  each  of  the  two  commodities.  Sometimes  one  or 
both  of  the  jointly  produced  commodities  will  have  to  compete 
in  the  market  with  substitute  commodities  produced  under 
other  conditions,  and  this,  of  course,  tends  to  limit  the  possible 
range  of  price  variation. 

When,  as  often  happens,  two  commodities  are  produced  under 
conditions  of  partially  joint  expenses,  further  processes  being 
necessary  to  fit  each  commodity  for  the  market,  the  price  must 
in  each  case  cover  the  specific  or  assignable  expense.  The 
joint  expenses  will  be  assigned  to  one  or  the  other  of  the  commod- 
ities, or  apportioned  between  them,  according  to  the  relative 
demand  for  them.  So  far  as  the  expenses  are  joint  they  are  in 
some  respects  similar  to  the  fixed  expenses  of  any  establishment 
producing  under  the  ordinary  conditions  of  fixed  and  variable 
expenses.  In  a  sense  all  fixed  expenses  are  the  joint  expenses 
of  producing  the  different  units  of  output,  while  all  variable  ex- 
penses are  specifically  assignable  to  the  different  units  of  the 
product.  But  this  analogy  must  not  be  pushed  too  far,  and  that 
for  two  reasons:  (i)  Most  establishments  with  fixed  and  va- 
riable expenses  have  to  accept  one  uniform  price  for  the  different 
units  of  their  product.  Their  fixed  charges,  unlike  true  joint 
expenses,  cannot  be  covered  by  the  price  of  one  portion  of  the 
output  and  disregarded  in  the  price  of  another  portion.  (2)  Even 
if  an  establishment  is  producing  two  or  more  different  commodi- 
ties or  is  able  to  sell  one  commodity  in  two  or  more  different 
markets  at  different  prices,  its  fixed  expenses  are  not  true  joint 
expenses  except  in  so  far  as  its  output  is  necessarily  accompanied, 
without  additional  expense,  by  the  production,  or  partial  pro- 
duction, of  another  part  of  their  output.  The  importance  of 
this  is  that,  as  we  have  seen,  an  increase  or  decrease  in  the 
aggregate  product  of  an  industry  must  ultimately  increase  or 
decrease  the  fixed  expenses  of  that  industry.     Fixed  expenses 


VALUE  AND   PRICE  181 

thus  enter  in  the  long  run  into  the  determination  of  the  normal 
price  of  all  portions  of  the  industry's  output.  This  is  not  true  of 
joint  expenses,  for  these  affect  only  what  we  have  termed  the 
collective  normal  price  of  the  joint  products.  Thus  neither  steaks 
nor  hides  have  a  separate  normal  price.  But  each  standard 
grade  or  type  of  product  in  the  output  of  the  furniture  industry 
has  a  normal  price  of  its  own. 

The  Surplus  of  Bargaining.  —  Demand  and  supply  do  not 
always  fix  price  at  a  definite  point.  The  price  of  horses  of  any 
given  grade,  for  example,  is  fixed  only  approximately  by  market 
conditions.  In  the  sale  of  a  horse  there  is  room  for  considerable 
latitude  of  opinion  as  to  the  price  that  should  be  paid.  If 
the  lowest  price  that  the  seller  will  take  is  considerably  below 
the  highest  price  that  the  buyer  will  give,  just  where  between 
these  limits  the  actual  price  will  be  finally  fixed  will  depend 
upon  the  relative  skill  at  bargaining  of  the  seller  and  buyer.  In 
the  case  of  a  horse  trade,  this  opportunity  for  the  "  higgling  of 
the  market  "  has  become  proverbial,  and  in  many  other  kinds 
of  exchanges  the  efficient  bargainer  has  an  opportunity  to  get 
for  himself  a  surplus  above  his  minimum  selling  price,  or  below 
his  maximum  buying  price.  Real  estate  transactions  furnish 
a  good  example.  In  the  case  of  the  great  commodities  of  the 
world  market,  like  wheat,  cotton,  and  iron,  the  price  is  set  so 
accurately  by  market  conditions  that  the  gains  of  bargaining 
are  relatively  small.  In  general,  the  wider  the  market,  the  more 
general  the  use  of  tlie  commodity,  the  greater  the  case  with  which  the 
commodity  can  be  sorted  into  standard  grades  (as  in  the  case  of 
wheat  and  cotton) ,  the  more  accurately  will  competitive  forces  fix  a 
definite  price.  Goods  which  cannot  be  standardized,  each  unit  of 
which  possesses  some  unique  qualities,  give  most  scope  for  the  varia- 
tions in  the  valuations  of  individual  buyers  and  sellers.  In  such 
cases  supply  and  demand  do  not  fix  a  price  point,  but  only  cer- 
tain limits  within  which  the  price  must  fall.  The  widening  of 
the  market,  however,  and  the  increasing  standardization  of 
commodities  —  an  effect  of  machine  production  —  are  bringing 
a  larger  and  larger  proportion  of  goods  into  the  field  where 
uniform  market  valuations  dominate. 


182  OUTLINES  OF  ECONOMICS 

Non-reproducible  Goods.  —  Some  economic  writers  have 
made  a  special  class  of  such  goods  as  great  works  of  art.  These 
are  absolutely  unique,  in  that  no  copy  can  have  anything  like 
the  value  of  the  original.  The  price  of  such  non-reproducible 
goods  has  an  upper  limit  fixed  by  the  highest  subjective  valua- 
tion set  upon  it  by  any  possible  buyer.  The  lower  limit  will 
be  either  the  seller's  own  subjective  valuation,  or  the  second 
highest  valuation  set  by  any  competing  buyer,  according  as 
one  or  the  other  of  these  two  is  the  higher.  Between  the  upper 
and  lower  limit  the  exact  fixing  of  the  price  is  a  matter  of  pure 
bargaining.  Such  cases  should  not  be  confused  with  monopoly 
price,  as  has  been  done  by  some  writers.  The  products  of  almost 
all  the  industrial  handicrafts,  as  well  as  the  products  of  the 
avowedly  artistic  pursuits,  possess  a  non-reproducible  element 
of  individuality,  that  removes  them  to  a  greater  or  less  extent 
from  the  operations  of  the  law  of  normal  price.  A  commodity 
may  possess  this  quality  of  uniqueness  to  such  an  extent  that 
it  is  not  affected  at  all  by  the  forces  determining  the  value  of 
the  general  class  of  goods  to  which  it  belongs,  and  in  this  case 
its  owner  may  be  said  to  have  a  monopoly  of  it.  But  it  is 
better  to  look  upon  the  valuations  of  such  non-reproducible 
goods  as  determined  by  individual  valuations  and  the  process 
of  bargaining.  The  "  normal  "  price  of  such  goods  is  simply  the 
highest  price  that  can  be  got  for  them  —  a  statement  which 
does  not  hold  true  of  most  monopoly  goods.  For  monopoly 
goods  are  not  necessarily  unique  or  non-reproducible.  They 
differ  from  ordinary  competitive  goods,  however,  in  that  they 
cannot  be  reproduced  except  by  the  monopolist. 

Retail  Prices.  —  The  retail  prices  paid  by  the  individual  con- 
sumer do  not  always  respond  to  all  the  variations  in  wholesale 
prices  brought  about  by  changes  in  supply  and  demand.  There 
are  sometimes  tacit  or  explicit  local  price  agreements  between 
local  merchants,  which  apply  even  to  competitively  produced 
goods.  Some  retailers  consistently  sell  a  few  kinds  of  goods  at 
less  than  cost  to  attract  custom  for  the  goods  on  which  they 
mav  make  a  profit.  Merchants  who  make  a  specialty  of  a 
high  class  of  goods,  and  thus  cater  to  a  wealthy  clientele,  are 


VALUE  AND   PRICE  183 

apt  to  exact  higher  prices  for  ordinary  goods  than  do  those 
merchants  who  have  to  deal  with  a  poorer  class  of  customers. 
Custom  has  more  effect  on  retail  than  on  wholesale  prices.  The 
prices  of  various  articles  sold  as  "  men's  furnishing  goods  " 
form  a  good  example  of  the  influence  of  custom.  Retail  prices 
are  also  governed  by  the  value  of  the  coins  that  are  in  general 
use,  and  are  generally  expressed  in  round  numbers.  In  the 
long  run,  demand  and  supply  govern  retail  prices,  but  they  do 
not  set  a  definite  price  point  so  accurately  as  they  do  in  the  case 
of  wholesale  prices. 

Public  Authority  and  Value.  —  In  the  Middle  Ages  there  was 
considerable  speculation  by  theologians  and  legists  about  the 
subject  of  "  just  price  "  —  the  value  at  which  things  ought  to 
exchange  for  other  things.  This  idea  denotes  an  important 
difference  between  the  medieval  and  modern  concept  of  value. 
Professor  Ashley  has  put  it  clearly  in  these  words :  "  With  Aqui- 
nas, the  greatest  of  the  medieval  schoolmen,  it  [value]  was  some- 
thing objective ;  something  outside  of  the  will  of  the  individual 
purchaser  or  seller ;  something  attached  to  the  thing  itself, 
existing  whether  he  liked  it  or  not,  and  that  he  ought  to  rec- 
ognize. And  as  experience  showed  that  individuals  could  not 
be  trusted  thus  to  admit  the  real  value  of  things,  it  followed  that 
it  was  the  duty  of  the  proper  authorities  of  state,  town,  or  gild 
to  step  in  and  determine  it,  and  what  the  just  and  reasonable 
price  really  was."  This  "  just  and  reasonable  price  "  was  very 
often  thought  to  be  that  price  which  would  afford  a  reasonable 
compensation  for  the  labor  of  the  producer.  When  in  more 
modern  times  theological  speculations  began  to  yield  prece- 
dence to  inquiries  into  "  natural  laws,"  the  idea  of  just  price 
was  supplanted  by  the  idea  of  "  natural  price."  Sometimes 
this  was  interpreted  as  determined  by  the  value  of  the  labor  put 
into  a  commodity  (this  was  the  dominant  idea  during  the  eight- 
eenth century),  but  the  growth  of  capitalistic  production 
necessitated  the  recognition  of  the  other  elements  in  the  expense 
of  producing  a  commodity  as  part  of  its  natural  price.  Modern 
economic  science,  as  we  have  seen,  applies  the  term  "  normal 
price"  to  the  expense  of  producing  a  thing,  but  interprets  it 


1 84  OUTLINES  OF   ECONOMICS 

only  as  an  important  factor  controlling  the  long-period  fluctua- 
tions of  market  prices.  The  adjective  "  natural,"  with  its  mis- 
leading implications,  has  been  abandoned.  Yet  the  competitive 
system  is  today  so  thoroughly  accepted  as  the  "  natural  " 
economic  order,  that  there  is,  as  we  have  previously  noted,  a 
deep-seated  conviction  that  normal  competitive  prices  (meas- 
ured by  the  expenses  of  production)  are  natural  and  just  prices. 
This  conviction  is,  however,  brought  face  to  face  with  the  fact 
'of  the  growth  of  a  large  industrial  field  in  which  monopoly, 
rather  than  competition,  rules.  The  question  of  just  price  is 
again  a  live  issue  —  as  it  was  before  the  growth  of  the  com- 
petitive system.  Public  authority  is  frequently  invoked  to 
insure  that  the  prices  fixed  by  holders  of  municipal  franchises 
and  other  monopolists  are  just  and  reasonable.  The  chief 
fundamental  test  which  our  courts  are  able  to  apply  to  the 
reasonableness  of  any  particular  price  is  its  conformity  to  what 
the  price  would  have  been  under  competitive  conditions.  Thus 
it  is  often  asked  if  a  particular  monopoly  charge  gives  a  more 
than  normal  return  upon  the  capital  invested.  The  deter- 
mination of  what  the  expense  of  producing  a  particular  com- 
modity or  service  really  is,  is  often  a  difficult,  or  even  impossible, 
task  (the  distinction  between  constant  and  variable  expenses 
being  frequently  a  stumbling-block),  but,  given  the  general 
acceptance  of  the  competitive  system,  it  is  hard  to  see  what 
other  standard  could  be  used.  Moreover,  the  general  consensus 
of  recent  court  decisions  is  that  the  Fifth  and  Fourteenth  Amend- 
ments to  the  Federal  Constitution,  prohibiting  the  taking  of 
property  without  due  process  of  law,  prevent  federal  and  state 
governments  from  going  farther  than  this  in  the  regulation  of 
monopoly  charges.  And  even  this  power  is  not  conceded, 
except  in  the  case  of  businesses  affected  with  a  distinct  public 
interest,  such  as  those  conducted  by  so-called  public- service 
corporations.  In  fixing  prices  for  its  own  services,  such  as 
postal  charges,  the  government  is  controlled  by  other  considera- 
tions. These  will  be  discussed  in  the  chapters  on  public  finance. 
Imputed  Value.  —  The  only  things  to  which  market  valuations 
actually  apply  are  the  specific  units  of  goods  that  are  actually 


VALUE  AND   PRICE  185 

bought  and  sold.  We  are  accustomed,  however,  to  impute  these 
market  prices  to  all  other  existing  goods  of  the  same  kinds. 
When  wheat  is  sixty  cents  a  bushel,  the  only  bushels  of  wheat 
actually  valued  by  the  market  at  that  price  are  the  ones  actually 
sold  at  that  price.  Yet  we  impute  or  ascribe  the  same  value 
to  all  other  bushels  of  the  potential  supply  of  wheat  in  the  same 
market. 

Notwithstanding  the  hypothetical  nature  of  this  imputed 
value,  it  is  often  treated  as  though  it  were  a  real  thing.  Statis- 
tical attempts  to  state  the  wealth  of  a  nation  in  terms  of  dollars 
and  cents  are  only  estimates  of  the  sums  of  these  imputed  values. 
A  merchant's  inventory  of  his  stock  in  trade  is  often  accompanied 
by  an  estimate  of  its  value.  Whether  this  value  will  be  realized 
or  not  depends  upon  the  constancy  of  business  conditions,  the 
caprices  of  fashion,  and  whether  it  can  be  sold  in  the  regular  course 
of  trade  or  whether  it  has  to  be  disposed  of  at  a  forced  sale. 
Many  kinds  of  consumption  goods,  such  as  household  furniture, 
are  not  customarily  thought  of  by  the  owner  in  terms  of  ex- 
change value.  It  is  often  necessary  for  purposes  of  taxation  to 
asc-ibe  value  to  them,  but  this  is  frequently  a  difficult  and 
somewhat  arbitrary  process. 

The  Prices  of  Production  Goods.  —  Throughout  our  analysis  of 
exchange  value  it  has  been  assumed  that  the  commodities  valued 
were  wanted  by  consumers  for  the  satisfaction  of  their  wants ; 
that  is,  that  they  were  consumption  goods.  It  is  not  altogether 
incorrect  to  say  that  producers'  goods  —  capital  and  land  — 
have  a  marginal  utility,  which  varies  with  the  importance 
attached  to  the  possession  of  them.  While  one  could  thus,  with 
substantial  accuracy,  include  producers'  goods  in  the  scope  of 
the  foregoing  analysis,  there  is  a  more  instructive  way  of  ap- 
proaching the  problem  of  the  prices  of  land  and  of  capital. 
Consumption  goods  have  value  because  they  satisfy  human 
wants ;  that  is,  they  yield  an  income  of  satisfactions,  while 
production  goods  are  valued  because  they  have  the  power  of 
gaining  a  money  income  for  the  owner.  Just  as  the  values  of 
consumers'  goods  vary  with  the  intensity  of  the  wants  they 
satisfy,  so  the  values  of  producers'  goods  vary  with  their  power 


1 86  OUTLINES  OF  ECONOMICS 

to  yield  a  money  income.  The  problem  of  the  prices  of  pro- 
ducers' goods  will,  accordingly,  be  discussed  in  the  chapters 
on  the  rent  of  land  and  the  interest  on  capital. 

Other  Theories  of  Value.  —  The  older  economists  used  to  em- 
phasize the  relation  between  the  price  of  a  thing  and  the  amount 
or  the  expense  of  the  labor  spent  in  producing  it,  —  a  relation 
much  closer  under  the  old  methods  of  hand  production  than  it 
is  at  present.  The  development  of  a  systematic  labor  theory 
of  value  was,  however,  the  work  of  Karl  Marx,  the  founder  of 
modern  "  scientific  "  socialism.  This  theory  is,  in  essence,  that 
labor  produces  all  value  and  that  the  interest  on  capital  and  the 
rent  of  land  are  deductions  from  the  real  wages  of  labor  —  de- 
ductions that  are  made  possible  only  by  the  existence  of  the 
system  of  private  property  in  producers'  goods.  It  is  so  ob- 
vious that  things  do  not  exchange  today  in  proportion  to  the 
amount  of  labor  involved  in  producing  them,  that  to  point  this 
out  in  detail,  as  some  economists  have  done,  is  unnecessary. 
Karl  Marx  himself  recognized  that  his  "  values  "  were  not 
measured  by  the  actual  prices  of  the  market.  They  seem  to 
hive  been  conceived  as  some  mysterious  essence  or  quality  in 
things.  But  the  only  economic  values  that  can  be  recognized 
from  the  modern  scientific  point  of  view  are  the  values  that 
really  exist  —  the  actual  values  of  the  market.  Nor  can  we 
say  that  things  ought  to  exchange  in  proportion  to  their  labor 
costs,  without  begging  the  whole  question  in  favor  of  the  aboli- 
tion of  private  property  in  land  and  capital.  Moreover,  it 
will  be  shown  later  that  rent  and  interest  would  not  be  elim- 
inated, although  they  might  be  changed  in  form,  by  a  change 
from  private  to  common  ownership  of  producers'  goods.  Al- 
though the  labor  theory  of  value  is  still  held  by  many  followers 
of  Marx,  its  place  in  the  creed  of  scientific  socialism  is  diminish- 
ing in  importance. 

The  relation  between  price  and  the  expenses  of  production 
has  sometimes  been  stated  in  such  a  way  as  to  lead  to  the  infer- 
ence that  cost  of  production  is  the  cause  of  value.  The  expense 
of  production  theory  of  price,  when  so  stated,  is  open  to  much 
the  same  objections  as  the  labor  theory.     Suppose  I  perfect  a 


VALUE   AND   PRICE  1 87 

machine  at  the  expense  of  ten  thousand  dollars  which  will  blow 
soap  bubbles  at  the  rate  of  a  thousand  an  hour.  Will  it  be 
worth  ten  thousand  dollars?  Certainly  not;  but  why  not? 
The  theory  of  costs  will  not  explain  it.  To  say  that  the  labor 
and  materials  have  not  been  wisely  used  is  simply  to  say  that 
the  machine  has  no  value,  which  is  just  what  we  are  trying  to 
explain.  As  a  fact,  it  is  not  worth  ten  thousand  dollars  simply 
because  no  one  is  willing  to  give  ten  thousand  dollars  for  it. 
The  expenses  of  production  do  not  create  value,  but  there  is  a 
sense  in  which  price  is  the  cause  of  the  expenses  of  production. 
That  is,  men  think  it  worth  while  to  expend  money  in  producing 
things  because  they  think  that  the  products  will  sell  for 
enough  to  recompense  them  for  the  expenses  of  production. 

Many  of  the  economists  who  have  written  in  the  past  about 
the  subject  of  price  took  the  facts  of  demand  for  granted,  and 
devoted  most  of  their  treatment  of  the  subject  to  an  examina- 
tion of  the  relation  between  price  and  the  expenses  of  produc- 
tion. This  was  in  part  an  expression  of  a  general  tendency  to 
regard  the  production  of  wealth  as  something  to  be  desired  for 
its  own  sake ;  the  fact  that  the  satisfaction  of  human  wants  is 
the  real  goal  of  most  economic  efforts  being  underemphasized. 
In  more  recent  years  economic  writers  have  developed  the  analy- 
sis of  human  wants ;  the  fact  that  utility  in  the  economic  sense 
is  not  utility  in  general,  but  the  utility  of  a  particular  unit  of  a 
commodity,  being  the  most  significant  point  in  this  new  analysis. 
Some  writers  have  even  gone  so  far  as  to  take  the  facts  of  supply 
for  granted,  and  to  assume  that  price  is  explained  when  mar- 
ginal utility  is  described.  As  a  determining  cause  of  price, 
utility  has  a  logical  priority  over  scarcity,  in  the  sense  that 
demand  is  usually  the  cause  of  supply.  Yet  in  the  analysis  of 
the  actual  price-making  process  we  have  to  recognize  that  util- 
ity and  scarcity,  demand  and  supply,  are  forces  operating  simul- 
taneously, neither  of  which  can  be  neglected  without  obscuring 
the  fundamental  facts  of  the  market. 


1 88  OUTLINES  OF   ECONOMICS 


QUESTIONS 

i.  Is  there  any  relation  between  the  price  of  a  lead  pencil  and  the  expense 
of  producing  it? 

2.  What  elements  of  a  farmer's  expenses  are  "constant"?  What  are 
"variable"? 

3.  What  different  possible  standards  of  just  price  can  you  suggest? 

4.  Combine  demand  curves  with  long-period  supply  curves  like  those 
shown  on  page  175  (the  general  conditions  of  demand  being  assumed  to 
be  constant)  and  interpret  the  meaning  of  the  resulting  diagrams. 

5.  Are  the  passenger  service  and  the  freight  service  of  a  railway  joint 
products? 

6.  What  different  possible  meanings  can  be  attached  to  the  expression 
"natural  value"? 

7.  Discuss  the  following  statement : 

"The  fact  is  that  labor  once  spent  has  no  influence  on  the  future  value  of 
any  article ;  it  is  lost  and  gone  forever.  In  commerce  bygones  are  forever 
bygones;  and  we  are  always  starting  clear  at  each  moment,  judging  the 
value  of  things  with  a  view  to  future  utility." — Jevons,  Theory  of  Political 
Economy,  p.  164. 

REFERENCES 

Chapman,  S.  J.    Outlines  of  Political  Economy,  Chaps,  xv-xvii. 

Flux,  A.  W.     Economic  Principles,  Chaps,  iv  and  v. 

Marshall,  Alfred.     Principles  of  Economics,  6th  ed.,  Book  v,  Chaps. 

ii-viii,  xi. 
Mill,  J.  S.     Principles  of  Political  Economy,  Book  iii,  Chaps,  iii  and  iv„ 
Taussig,  F.  W.    Principles  of  Economics,  Vol.  i,  Chaps,  xii-xiv,  xvi. 
Wieser,  F.  von.    Natural  Value,  Book  v,  Chaps,  i-vi. 


CHAPTER   XII 
MONOPOLY 

The  Idea  of  Monopoly.  —  One  of  the  economic  terms  most  fre- 
quently used  nowadays  is  monopoly,  and  at  the  same  time  it 
is  one  of  those  terms  which  are  peculiarly  vague  and  ill-defined 
in  popular  discussion.  Even  in  law  and  economics,  contradic- 
tory meanings  have  been  attached  to  the  term,  although  recently 
there  has  been  a  marked  clarification  of  thought  both  on  the  part 
of  economists  and  jurists.  While  there  has  been  confasion  of 
thought  with  respect  to  monopoly,  all  have  agreed  that  some- 
thing to  be  called  monopoly  has  existed,  and  that  it  has  been 
the  cause  of  perplexing  scientific  and  practical  problems. 

In  economics,  as  in  life,  categories  shade  off  into  each  other, 
and  at  the  boundaries  discrimination  is  difficult.  It  is  best, 
therefore,  to  find  highly  developed,  plainly  marked  types  to  fur- 
nish us  the  subject-matter  for  definition  and  to  compare  one  type 
with  another.  This  is  an  especially  desirable  mode  of  procedure 
in  the  present  case,  because  the  term  "  monopoly  "  at  once  sug- 
gests the  term  "  competition,"  with  which  it  is  inevitably  con- 
trasted. When  monopoly  exists,  competition  is  thought  of  as 
absent.  A  state  of  full  and  free  competition,  on  the  other  hand, 
is  incompatible  with  monopoly. 

Competition  means  a  market  with  rival  sellers  and  buyers, 
and  prices  determined,  on  the  one  hand,  by  efforts  of  sellers, 
acting  independently  of  one  another,  to  dispose  of  commodities 
and  services,  and  on  the  other  hand,  by  efforts  of  purchasers, 
acting  independently  of  one  another,  to  secure  commodities  and 
services.  We  have  seen  the  forces  that  under  competition  limit 
producers  and  purchasers,  and  thus  determine  prices,  and  we 
have  seen  that  competitive  prices  are  beyond  the  control  of  any 
one  buyer  or  seller. 

189 


190  OUTLINES  OF   ECONOMICS 

Monopoly,  as  the  term  contrasted  with  competition,  means 
combination  and  unified  action,  signifying  restraint  on  the  free 
offering  of  commodities  and  services  by  rival  sellers  and  on  the 
free  purchase  of  these  commodities  and  services  by  rivals  who 
desire  to  secure  them.  The  word  "  monopoly  "  itself  means  a 
condition  in  which  there  is  a  single  seller  or  a  single  purchaser, 
and  signifies  unity  in  management  of  some  kind  of  business  in 
some  essential  particular. 

The  particular  in  which  unity  is  secured  in  the  case  of  monop- 
oly may  be  in  production,  it  may  be  in  sales,  it  may  be  in  pur- 
chases ;  or  it  may  be  in  any  two  or  all  three  of  these  particulars. 
This  use  of  the  term  "  monopoly  "  gives  us  a  clear  scientific 
concept  which  is  workable ;  and  on  its  basis  we  may  then  formu- 
late this  definition  of  monopoly :  Monopoly  means  that  substan- 
tial unity  of  action  on  the  part  of  one  or  more  persons  engaged  in 
some  kind  of  business  -which  gives  exclusive  control,  more  particu- 
larly, although  not  solely,  with  respect  to  price. 

This  definition  of  monopoly  is  in  accordance  with  good  English 
usage,  and  is  also  in  harmony  with  the  meaning  given  to  the 
corresponding  word  in  other  modern  languages  by  those  who 
use  these  languages  with  discrimination.  In  legal  utterances, 
too,  though  they  have  been  contradictory  and  inconsistent  in 
various  particulars,  we  find,  nevertheless,  a  sound  tendency  to 
emphasize  unified  control  of  business  as  an  essential  character- 
istic of  monopoly.1 

The  Idea  of  Monopoly  and  Industrial  Evolution.  —  But  the 
meanings  of  economic  categories  change  with  industrial  evolu- 
tion. Even  such  terms  as  freedom  and  liberty  have  to  be  newly 
interpreted  with  every  new  stage  and  even  with  every  marked 


1  Lord  Coke,  in  the  seventeenth  century,  said  that  monopoly  consisted  of  power 
granted  "  to  any  person  or  persons,  bodies  politic  or  corporate,  for  the  sole  buying, 
celling,  making,  working,  or  using  of  anything,  whereby  any  person  or  persons,  bodies 
politic  or  corporate,  are  sought  to  be  restrained  of  any  freedom  or  liberty  that  they 
had  before,  or  hindered  in  their  lawful  trade  "  (3  Institutes,  181).  Blackstone,  in  his 
Commentaries  on  the  Laws  of  England,  gave  almost  precisely  the  same  definition  in 
the  following  century.  The  Supreme  Court  of  the  United  States  (National  Cotton 
Oil  Co.  v.  Texas,  197  U.  S.  129)  has  accepted  the  definition  of  monopoly  given  i» 
the  text,  above. 


MONOPOLY  191 

phase  in  a  stage  of  economic  life.  Naturally  monopoly  has 
acquired  a  new  significance,  requiring  new  interpretation.  The 
earlier  legal  definitions  made  monopoly  proceed  from  an  express 
grant  of  public  authority.  Lord  Coke  says:  "A  monopoly 
is  an  institution  or  allowance  by  the  king,  by  his  grant,  commis- 
sion, or  otherwise  " ;  and  Blackstone  uses  similar  language  in 
defining  monopoly  "as  a  license  or  privilege  allowed  by  the 
king." 

Historically,  this  source  of  monopoly  power  is  of  paramount 
importance.  From  early  times,  English  sovereigns  granted  mo- 
nopolies either  for  public  or  private  reasons,  and  they  became  a 
grievous  burden.  Queen  Elizabeth,  in  particular,  sinned  in  this 
respect,  regarding  the  right  to  grant  monopolies  as  "  one  of  the 
fairest  flowers  "  in  her  prerogative,  and  it  was  not  long  before 
the  citizen  found  himself  restrained  and  shut  in  on  every  side  by 
a  privileged  class  of  monopolists.  In  1603,  it  was  decided,  in  a 
famous  case,  with  respect  to  one  of  Queen  Elizabeth's  grants : 
"  That  it  is  a  monopoly  and  against  the  common  law.  All 
trades  as  well  mechanical  as  others  which  prevent  idleness  (the 
bane  of  the  Commonwealth)  and  exercise  men  and  youth  in  labor 
for  the  maintenance  of  themselves  and  their  families,  and  for 
the  increase  of  their  substance  to  serve  the  Queen  when  occasion 
shall  require  are  profitable  for  the  Commonwealth,  and  therefore 
the  grant  to  have  the  sole  making  of  them  is  against  the  common 
law  and  the  benefit  and  liberty  of  the  subject."  Parliament,  in 
1624,  passed  a  statute  declaring  that  "  all  monopolies  are  alto- 
gether contrary  to  the  laws  of  this  realm  and  are  and  shall  be 
void  and  of  no  effect."  Exceptions  to  this  rule  were  sometimes 
made  upon  one  ground  or  another,  but  the  general  principle  of 
the  illegality  of  special  grants  of  monopoly  became  thoroughly 
established  in  English  law. 

Our  forefathers  were  so  deeply  impressed  with  the  evils  which 
they  had  suffered  at  the  hands  of  the  monopolists  in  old  England 
that  in  the  Bills  of  Rights  and  elsewhere  in  the  early  constitutions 
of  our  commonwealths  they  frequently  inserted  severe  denun- 
ciations of  monopolies,  and  prohibited  them  unqualifiedly ;  and 
these  declarations  and  prohibitions  still  last  in  several  states. 


192  OUTLINES   OF   ECONOMICS 

Two  illustrations  will  suffice.  We  read  the  following  utterance 
in  Article  39  of  the  Declaration  of  Rights  which  forms  part  of  the 
constitution  of  Maryland :  "  Monopolies  are  odious,  contrary  to 
the  spirit  of  a  free  government  and  the  principles  of  commerce, 
and  ought  not  to  be  suffered."  And  the  people  of  Texas  still 
cherish  Section  26  of  Article  1  of  their  constitution,  which  among 
other  things  declares  that "  monopolies  are  contrary  to  the  genius 
of  a  free  government,  and  shall  never  be  allowed." 

While  the  spirit  of  monopoly  is  as  old  as  man,  there  was  until 
this  century  comparatively  little  opportunity  for  monopoly  on 
any  large  scale  save  as  it  proceeded  from  express  grants  of  public 
authority.  These  grants  were  sometimes  made  for  public  pur 
poses,  and  sometimes  they  proceeded  from  mere  abuse  of 
monarchical  power,  and  were  given  to  favorites  of  royalty 
We  cannot  now  stop  to  discuss  their  merits  and  demerits,  but 
call  attention  to  the  fact  that  they  became  odious,  and  were 
prohibited  both  in  England  and  in  this  country,  exception  being 
made  of  patents  and  copyrights.  At  the  present  time,  however, 
monopolies  proceed  from  the  nature  of  industrial  society,  and 
are  of  far  greater  significance  in  our  economic  and  political  life 
than  ever  before.  The  really  serious  monopolies  of  our  day  are 
far  more  subtle,  and  have  for  the  most  part  grown  up  outside 
of  the  law,  and  even  in  spite  of  the  law.  Framed  with  a  view 
to  only  one  kind  of  monopoly,  our  law  was  at  first  wholly  inade- 
quate to  cope  with  these  new  and  varied  manifestations  of 
monopoly.1 

Things  Sometimes  Confused  with  Monopoly.  —  We  must  dis- 
tinguish sharply  between  a  condition  of  monopoly  and  other 
conditions,  if  we  are  to  think  clearly  and  accurately.  One  thing 
which  does  not  yield  monopoly  is  mere  limitation  of  supply, 

1  Modem  industrial  monopolies  are  often  quite  as  much  akin  to  the  offense  known 
in  the  old  English  law  as  "engrossing"  as  they  are  to  the  old  notion  of  a  monopoly 
granted  as  a  special  privilege.  The  engrosser  was  one  who  bought  large  stocks  of 
goods  in  a  market  or  on  their  way  to  a  market  with  the  purpose  of  selling  them  later 
at  a  higher  price.  The  opposition  to  engrossing  seems  to  have  been  based  partly 
on  hostility  to  unnecessary  middlemen  and  partly  on  the  fear  of  temporary  monopo- 
lies, created  by  "cornering  the  market."  Later,  tht  terms  engrossing  and  monop- 
olizing came  to  be  generally  used  as  synonymous  in  court  decisions. 


MONOPOLY  193 

and  it  is  strange  that  even  an  economist  of  the  ability  of  John 
Stuart  Mill  should  have  found  the  essential  feature  of  monopoly 
in  this  limitation ;  for  this  at  once  makes  monopoly  cover  the 
entire  field  of  economic  activity,  inasmuch  as  economic  activity 
is  for  the  acquisition  of  valuable  things,  and  things  lack  value 
whenever  their  supply  is  adequate  for  the  satisfaction  of  all 
wants.  It  is  only  things  limited  in  proportion  to  human  desires 
that  have  exchange  value. 

Nor  may  we  say  that  a  valuable  thing  is  monopolized  because 
its  supply  is  limited  and  also  graded  in  quality.  Land  exists  in 
quantities  to  which  physical  nature  has  assigned  limits,  and  the 
supply  of  land  exists  in  grades  varying  in  fertility  and  desirability 
of  situation,  and  as  a  consequence  of  this  limitation  and  grada- 
tion we  have  the  rent  of  land.  Land  is  not,  however,  a  monopoly, 
and  it  is  misleading  to  speak  of  it  as  a  natural  monopoly.  No- 
where do  we  find  monopoly  either  in  the  ownership  or  in  the 
cultivation  of  land,  but  everywhere  competition  —  competition 
among  unequals,  to  be  sure,  but  still  competition. 

Land  rent  is  a  differential  gain,  a  gain  due  to  the  superiority  of 
the  land  owned  by  rent  receivers  over  that  cultivated  by  those 
who  are  making  use  of  land  which  affords  nothing  beyond  returns 
to  labor  and  to  capital.  We  must  distinguish  between  the 
broad  concept  of  differential  gains  enjoyed  by  those  in  competi- 
tive pursuits,  and  the  monopolistic  gains  which  are  based  on  the 
absence  of  competition. 

Just  as  sharply  must  wTe  distinguish  between  competitive  busi- 
nesses of  large  magnitude  and  monopolies.  Department  stores 
in  no  city  in  the  world  enjoy  monopolies,  but  are  subjected  to  the 
steady,  permanent  pressure  of  competition.  There  are  those 
who  call  every  business  operating  on  a  vast  scale  monopoly,  and 
would  put  in  the  same  economic  category  a  gasworks  without  a 
competitor  and  a  huge  retail  dry-goods  establishment  with  rivals 
at  every  hand,  ready  to  seize  every  opportunity  for  an  advantage 
over  it,  and  certain  to  ruin  it  if  its  managers  relax  their  intense 
activity  and  watchfulness. 

Classification  and  Causes  of  Monopolies.  —  Monopoly  ap- 
pears to-day  in  so  many  different  forms  and  results  from  so  many 


194  OUTLINES  OF  ECONOMICS 

different  causes  that  the  classification  of  monopolies  is  a  neces- 
sary preliminary  to  clear  thinking  in  this  field. 

In  the  first  place,  we  must  note  that  there  are  (i)  public 
monopolies,  owned  and  operated  by  some  political  unit,  for  the 
benefit  of  the  community,  and  (2)  private  monopolies,  owned  by 
private  persons,  firms,  or  corporations,  and  operated  primarily 
for  their  own  benefit. 

In  the  second  place,  monopolies  may  be  (1)  local,  (2)  national, 
or  (3)  international.  This  classification  is  more  or  less  arbitrary, 
but  it  suggests  that  the  area  of  the  operation  of  a  monopoly 
is  a  matter  of  much  importance.  There  may  be  only  one  seller 
of  shoes  on  a  particular  street  or  in  a  particular  building.  We 
do  not  call  this  monopoly,  because  the  area  in  which  this  shoe 
dealer  is  without  competitors  is  much  smaller  than  the  area  in 
which  the  forces  which  fix  the  retail  price  of  shoes  operate.  It 
is  not  sufficient  that  one  should  be  the  only  seller  or  buyer  in  a 
certain  definite  area.  For  monopoly  to  exist  it  is  necessary 
that  the  unified  control  of  the  buying  or  selling  of  a  particular 
commodity  or  service  should  extend  throughout  the  area  of  the 
market,  whatever  that  area  may  happen  to  be.  The  supply  of 
gas,  or  of  street  railway  transportation,  is  in  most  cities  a  real 
monopoly,  because  the  market  in  such  cases  is  merely  local. 
Two  young  men  in  Chicago  some  years  ago  cornered  the  market 
on  eggs,  and  thereby  cleared  $15,000.  The  weather  was  so 
cold  that  eggs  could  not  be  shipped  to  the  city,  and  thus  the 
speculators  had  a  temporary  local  monopoly.  A  protective 
tariff  or  other  impediments  to  international  trade  may  some- 
times enable  a  monopoly  to  exist  in  one  country  when  the  same 
article  or  service  is  not  monopolized  in  another  country.  Various 
attempts  have  been  made  to  establish  international  monopolies, 
but  none  of  these  has  been  entirely  successful.  Agreements 
restricting  competition  between  the  producers  of  different  na- 
tions are  known  to  have  been  effected  in  the  steel  trade  and 
in  the  petroleum  trade. 

We  pass  now  to  a  third  classification  of  monopolies,  according 
to  the  source  of  monopoly  power.  This  classification  is  especially 
important,  because  we  shall  not  know  how  to  deal  effectively 


MONOPOLY  195 

with  monopolies  until  we  understand   just  why  and  how  the 
different  kinds  of  monopolies  have  come  into  being. 

A.  Social  Monopolies. 

I.  General  welfare  monopolies. 

1.  Patents. 

2.  Copyrights. 

3.  Public  consumption  monopolies. 

4.  Fiscal  monopolies. 

II.  Special  privilege  monopolies. 

1.  Those  based  on  public  favoritism. 

2.  Those  based  on  private  favoritism. 

B.  Natural  Monopolies. 

I.  Those  arising  from  limitation  of  supply  of  raw  ma- 
terial. 
II.  Those  arising  from  secrecy. 

III.  Those  arising  from  peculiar  properties  inherent  in 

the  business. 

Social  Monopolies.  —  Businesses  are  social  monopolies 1  when 

they  are  made  monopolies  not  by  their  own  inherent  properties,  but 

either  by  legislative  enactment  or  by  special  advantages  or  privileges 

granted  to  them  by  other  monopolies. 

Social  monopolies  cannot  exist  without  the  acquiescence  of 
society.  There  is  no  reason,  therefore,  why  social  monopolies 
should  be  permitted,  except  in  so  far  as  particular  social  monop- 
olies are  deemed  to  be  advantageous  means  of  achieving 
socially  desirable  ends. 

The  exclusive  privileges  conferred  (for  limited  periods)  by 
patent  and  copyright  laws  are  justified  by  the  stimulus  they  have 
given  to  invention  and  authorship.  Patents  lead  to  several 
different  kinds  of  monopolies.  In  some  instances  the  monopoly 
is  limited  to  the  control  of  the  supply  of  the  patented  article 
itself.  In  other  cases  the  use  of  a  patented  machine  or  process 
in  the  manufacture  of  some  other  product  may  give  advantages 
important  enough  to  create  a  monopoly  in  the  supply  of  that 
product.  Sometimes  the  owner  of  a  patent  endeavors  to  extend 
the  scope  of  his  monopoly  by  refusing  to  sell  his  patented  prod- 

1  Sometimes  called  "  artificial  monopolies." 


196  OUTLINES  OF  ECONOMICS 

ucts  except  on  the  condition  that  other  commodities,  used  in 
connection  with  the  patented  product,  be  purchased  from  him 
and  not  from  his  competitors.  Such  agreements  have  been  en- 
forced in  the  sale  of  mimeographs  and  of  shoe  machinery.  These 
"  tying  contracts  "  were  made  illegal  by  the  Clayton  Anti- 
Trust  Act  of  1 9 14.  Again,  the  patent  system  sometimes  operates 
so  as  to  perpetuate  a  monopoly  already  established.  Some  new 
inventions  cannot  be  profitably  utilized  except  in  connection 
with  machines  or  processes  which  have  previously  been  patented. 
For  this  and  other  reasons  it  frequently  happens  that  an  exist- 
ing monopoly  affords  the  only  market  for  the  improved  machines 
and  processes  adapted  to  some  particular  industry.  This  has 
been  an  important  factor  in  the  telegraph,  telephone,  and  elec- 
trical industries.  But  although  our  patent  laws  need  careful 
revision,1  the  policy  of  granting  inventors  a  temporary  monop- 
oly continues  to  meet  with  general  social  approval.  Copyrights 
stand  upon  even  firmer  ground.  To  do  away  with  copyrights 
would  not  only  lessen  the  incentives  to  authorship,  but  it  would 
also  prevent  the  publication  of  many  good  books. 

Trademarks,  like  patents,  are  monopolies  in  the  strictly  legal  sense  that 
no  one  else  may  use  them.  But,  unlike  patents,  they  do  not  lead  to  a 
monopoly  in  the  economic  sense  of  giving  exclusive  control  of  one  sort  of 
business.  They  are  used  largely  in  competitive  business  undertakings  as 
a  help  in  establishing  and  maintaining  what  is  termed  good-will.  The  law 
also  forbids  the  fraudulent  imitation  of  established  brands,  firm  names,  and 
distinctive  forms  of  packages.  In  so  far  ac  a  successful  business  man  in  a 
competitive  field  is  able  to  induce  people  to  believe  that  it  is  better  to  pur- 
chase his  particular  brand  of  goods  than  to  take  the  chance  of  getting  a 
possibly  inferior  quality  by  purchasing  his  competitor's  products,  he  may 
be  able  to  lift  himself  a  little  above  the  "dead  level"  of  competition.  He 
may  even  find  that  he  can  increase  his  net  profits  by  putting  the  price  of  his 
goods  somewhat  higher  than  that  at  which  precisely  similar  goods  are  sold 
in  the  market.  By  thus  successfully  marking  off  his  product  as  something 
distinct  from  and  possibly  superior  to  his  competitor's  goods,  he  is  able  to 
obtain  what  might  be  termed  a  quasi-monopoly.  But  because  his  power 
to  control  the  price  of  his  product  is  in  general  much  more  limited  than  that 
of  the  true  monopolist,  and  because  competition  limits  and  conditions  his 
activities  in  other  ways,  his  business  is  more  properly  called  competitive 
than  monopolistic. 

1  See  p.  23,  above. 


MONOPOLY 


197 


Public  consumption  monopolies  and  fiscal  monopolies  are  to  be 
distinguished  the  one  from  the  other  only  by  the  object  which 
the  government  has  in  view  in  establishing  them.  If  the  govern- 
ment manages  for  itself  or  grants  to  another  a  monopoly  of  the 
liquor  traffic  with  the  object  of  regulating  the  consumption,  the 
monopoly  is  a  public  consumption  monopoly.  If,  on  the  other 
hand,  the  chief  object  is  not  regulation,  but  revenue  for  the 
government,  the  monopoly  is  a  fiscal  one.  Often  the  two  objects 
are  blended.  The  production  of  salt  has  at  one  time  or  another 
been  a  fiscal  monopoly  in  many  different  countries.  The  sale 
of  tobacco  is  a  fiscal  monopoly  in  France.  In  recent  years 
Japan  has  established  a  number  of  fiscal  monopolies. 

The  old  monopolies  established  by  special  grant  of  the  sovereign 
were  in  some  cases  fiscal  monopolies,  a  heavy  tax  or  royalty  being 
paid  by  the  monopolist.  In  other  cases,  however,  they  were 
based  merely  on  public  favoritism.  A  monopoly  in  one  country, 
protected  by  a  high  tariff  from  the  competition  of  producers  in 
other  countries,  is  rightly  said  to  be  based,  so  far  as  all  or  part 
of  its  monopoly  power  is  concerned,  on  public  favoritism.  Mo- 
nopolies based  on  private  favoritism  derive  their  monopoly  power 
from  special  advantages  granted  them  by  other  monopolies, 
especially  natural  monopolies.  Railroad  rebates  have  been  in 
the  past  a  fruitful  source  of  monopoly. 

Natural  Monopolies.  —  These  depend  for  their  existence  on 
natural  forces  as  distinguished  from  social  arrangements.  They 
grow  up  independently  of  man's  will  and  desire  and  sometimes 
even  in  direct  opposition  to  it.  The  words  we  have  used  to 
designate  the  first  two  classes  of  natural  monopolies  are  self- 
explanatory.  Natural  mineral  waters  and  certain  wines  made 
from  grapes  that  are  grown  only  in  restricted  areas  are  often 
good  examples  of  monopolies  derived  from  special  limitations 
in  the  supply  of  raw  materials. 

The  Kimberley  mines,  of  South  Africa,  virtually  controlling 
the  amount  of  annual  additions  the  world's  stock  of  diamonds, 
constitute  a  monopoly  of  this  class.  The  limited  area  in  which 
anthracite  coal  is  produced  in  the  United  States  is  an  important 
contributing  cause  of  the  monopolistic  control  of  that  industry. 


198  OUTLINES  OF   ECONOMICS 

Monopolies  based  £>n  secrecy  are  no  longer  of  great  importance, 
although  the  use  of  secret  processes  remains  in  some  instances 
a  source  of  monopoly. 

By  far  the  most  important  of  all  monopolies  are  natural  monop- 
olies of  the  third  class,  arising  from  peculiar  properties  inherent 
in  the  business.  Among  such  monopolies  are  roads  and  streets, 
canals,  docks,  bridges  and  ferries,  waterways,  harbors,  light- 
houses, railways,  telegraphs,  the  post  office,  electric  lighting, 
waterworks,  gas  works,  and  street  railways  of  all  kinds.  What 
are  the  properties  inherent  in  such  businesses  that  make  them 
naturally  monopolistic  ?  In  some  instances  it  will  be  found  that 
the  possession  of  peculiarly  favorable  spots  or  lines  of  land  may 
give  advantages  important  enough  to  create  monopoly.  This 
may  be  true,  for  example,  of  harbors,  docks,  street  railways, 
rights  of  way  through  mountain  passes  or  along  narrow  river 
valleys,  and  railway  terminals  in  large  cities.  Often  these 
are  things  which  cannot  be  duplicated  at  all  or  can  be  dupli- 
cated only  at  a  practically  prohibitive  expense.  Monopolies 
created  by  the  presence  of  such  conditions  are  similar  to  natural 
monopolies  of  the  first  class. 

Natural  monopolies  of  this  third  class  are,  however,  more 
often  rooted  in  conditions  that  make  competition  self-destructive. 
These  conditions  are  three  in  number,  and  the  presence  of  all  of 
them  is  generally  necessary  to  create  monopoly :  (1)  The  com- 
modity or  service  rendered  must  be  of  such  a  nature  that  a  small 
difference  in  price  will  lead  buyers  to  purchase  from  one  pro- 
ducer rather  than  from  another.  (2)  The  business  must  be  of 
such  a  nature  as  to  make  the  creation  of  a  large  number  of  com- 
.petitive  plants  impossible.  Either  because  the  business  is  one 
in  which  special  advantages  attach  to  large-scale  production  or 
because  there  are  actual  physical  difficulties  in  the  way  of  the 
multiplication  of  competing  plants,  there  must  be  fairly  definite 
limits  to  the  possible  increase  of  the  number  of  plants  among 
which  the  business  might  be  divided.  (3)  The  proportion  of 
fixed  to  variable  expenses  of  production  must  be  high. 

These  conditions,  tne  reader  will  note,  are  conspicuously 
present  in  the  operation  of  railways  and  of  the  so-called  local 


MONOPOLY  199 

public  utilities,  as  well  as  in  other  industries  in  which  natural 
monopoly  prevails.  The  principal  reason  why  competition 
cannot  be  maintained  in  this  field  is  that  under  the  conditions  we 
have  listed  competition  fails  to  fix  a  normal  price  remunerative 
enough  to  attract  the  recurrently  necessary  fresh  investments 
of  capital.  Competition  succeeds  when  cither,  first,  the  ex- 
penses of  production  are  largely  variable  expenses,  or,  second, 
the  total  output  of  the  industry  comes  trom  a  large  number  of 
competing  business  units,  some  successful,  others,  very  likely, 
operating  on  the  narrowest  possible  margin  of  profits.  When 
either  of  these  two  conditions  is  present  in  an  industry,  the 
aggregate  amount  of  the  output  will  be  delicately  sensitive 
to  changes  in  market  price.  If  the  price  rises,  the  output  will 
be  increased ;  if  it  falls,  the  total  output,  and  with  it  the  total 
expenses  of  production,  will  be  diminished.  In  either  event 
the  change  in  price  will  be  checked,  and  through  this  process, 
market  prices  will,  in  the  long  run,  be  kept  just  about  high 
enough  to  induce  the  industry  to  maintain  an  output  of  whatever 
size  may  be  justified  by  the  demand  for  it.  That  is,  the  forces 
which  fix  a  normal  price  will  operate  effectively. 

But  if  there  are,  at  the  most,  only  relatively  few  competing 
establishments  in  an  industry,  if  fixed  expenses  are  relatively 
large  as  compared  with  variable  expenses,  and  if  the  market  for 
the  commodity  or  service  produced  is  quick  to  take  advantage 
of  price  cutting  on  the  part  of  one  or  more  of  the  establishments, 
it  will  be  difficult  to  maintain  competitive  conditions.  What 
would  happen  if  one  of  the  railways  running  between  Chicago 
and  New  York  should  reduce  its  freight  rates?  First,  it  would 
immediately  get  a  large  share  of  the  traffic.  Second,  the  other 
railways  would  be  forced  to  lower  their  rates,  so  that  if  the  first 
railway  desired  to  retain  its  increased  traffic  it  would  be  forced 
to  cut  rates  again.  Third,  it  is  clear  that  there  is  no  stopping 
point  in  this  process  of  competitive  rate  cutting,  so  long  as  the 
rates  suffice  to  cover  variable  expenses.  Fourth,  since  fixed 
expenses  must,  however,  be  paid,  the  competing  railroads  have 
to  choose  between  (a)  ultimate  bankruptcy,  and  (b)  the  main- 
tenance of  rates  at  a  level  fixed  by  joint  agreement.     This  second 


200  OUTLINES   OF   ECONOMICS 

alternative  means  unity  of  action,  or  monopoly.  Where  com- 
petition is  thus  self-destructive,  monopoly  is  inevitable.  The 
operation  of  this  principle  has  been  exemplified  many  times  in 
the  history  of  American  railways.  A  new  "  competing"  rail- 
road has  been  built,  it  has  cut  rates  to  attract  a  share  of  the 
traffic ;  a  rate  war  has  ensued ;  and  the  end  has  always  been  mo- 
noply  in  the  form  of  a  combination  or  rate  agreement.  A  simi- 
lar situation  is  found  in  the  case  of  local  public  service  companies. 
Twenty  or  thirty  years  ago  many  of  our  cities  adopted  the  mis- 
taken policy  of  trying  to  force  competition  into  this  naturally 
monopolistic  field.  But  very  often  it  was  found  that  the  mere 
threat  of  competition  was  sufficient  to  bring  about  combination 
and  monopoly. 

It  is  believed  by  some  that  the  advantages  of  large-scale  production 
increase  so  long  as  the  size  of  the  business  establishment  increases.  If 
this  were  true,  it  would  give  production  on  the  largest  possible  scale  advan- 
tages so  great  that  monopoly  would  result  in  all  parts  of  the  industrial  field . 
Some  socialists  believe  that  this  movement  is  so  strong  that  it  must  result 
in  the  final  disappearance  of  competition  and  the  triumph  of  monopoly 
everywhere.  Certain  other  students  of  the  problem  think  that  it  is  only  in 
certain  industries  that  the  economies  of  large-scale  production  are  sufficient 
to  lead  to  monopoly.  But  in  such  fields,  they  hold,  "capitalistic  monop- 
olies" are  sure  to  appear. 

It  should  be  remembered,  however,  that  the  very  large  business  establish- 
ment has  disadvantages  as  well  as  advantages ;  and  it  seems  probable  that 
beyond  a  certain  point  the  disadvantages  of  a  further  increase  in  size  grow 
more  rapidly  than  the  advantages.  In  most  industries  the  point  of  maxi- 
mum efficiency  is  reached  long  before  the  point  of  monopoly  is  reached. 
It  is  difficult,  and  perhaps  impossible,  to  find  a  single  instance  of  successful 
monopoly  in  which  one  or  more  of  the  definite  and  sp?c:fic  sources  of 
monopoly,  mentioned  in  the  foregoing  classification,  are  not  to  be  found 
Our  conclusion,  then,  may  be  stated  as  follows :  There  is  a  great  and  grow- 
ing field  of  industry  in  which  competition  is  not  natural  or  permanently 
possible;  there  is  another  field  within  which  monopoly  does  not  exist,  and 
in  which  it  cannot  exist  except  in  the  form  of  social  (or  artificial)  monopolies. 

Monopoly  Price.  —  The  chief  peculiarity  of  monopoly  price 
is  found  in  the  power  of  the  monopolist  over  supply.  This  is 
what  gives  the  monopolist  the  ability  to  secure  surplus  profits. 
In  competitive  industry  the  supply  is  not  within  the  control  of  a 


MONOPOLY  20 1 

single  producer,  and,  as  a  result,  prices  tend  to  be  controlled  or 
limited  by  the  expenses  of  production.  The  competitive  pro- 
ducer cannot  increase  his  profits  by  limiting  the  supply,  and  it 
is  on  this  account  that  the  law  regards  competition  as  one  of  the 
main  pillars  of  our  present  social  order. 

The  monopolist  will  normally  endeavor  to  fix  his  output  at 
such  a  point  that,  given  the  existing  state  of  demand,  he  will 
secure  the  highest  possible  net  returns.  On  the  one  hand  he  has 
to  face  the  fact  that  although  he  can  increase  his  gross  receipts 
up  to  a  certain  point,  by  increasing  his  output,  yet  the  increase 
in  gross  receipts  will  not  be  proportionate  to  the  increase  in  out- 
put, for  the  simple  reason  that  the  increased  output  will  not  find 
buyers  except  at  a  lower  price  per  unit.  On  the  other  hand  an 
increase  in  his  output  will  always  increase  his  aggregate  expenses 
of  production,  although  here  again  the  increase  (in  expense) 
may  not  be  proportionate  to  the  increase  in  output.  In  par- 
ticular there  are  likely  to  be  some  permanently  fixed  expenses 
which  will  be  the  same  for  a  small  output  as  a  large  one,  and  there 
may  be  other  expenses  which  will  not  increase  unless  the  output 
should  be  made  much  larger  than  would  be  profitable.  Indeed, 
it  may  often  happen  that  the  fact  that  a  large  output  would  make 
it  necessary  to  increase  certain  expenses  which  would  otherwise 
be  fixed  (such  as  the  cost  of  the  plant)  may  lead  the  monopolist 
to  choose  to  produce  a  relatively  small  quantity  of  goods.  The 
following  table  shows  in  parallel  columns  the  number  of  sales  of  a 
monopolized  good  at  different  prices,  the  total  resultant  receipts, 
the  variable  expenses,  the  fixed  expenses,  the  total  expenses,  and, 
finally,  the  net  revenue  or  monopoly  profit.  For  the  sake  of 
simplicity  it  is  assumed  that  all  of  the  fixed  expenses  are  perma- 
nently constant,  at  least  for  such  possible  increase  of  output  as 
the  monopolist  cares  to  consider. 

Study  of  the  table  will  show  that,  in  the  case  assumed  here, 
the  monopoly  price  will  stand  at  six  cents.  It  would  be  possible 
for  the  monopolist  to  produce  5,500,000  units,  for  this  would  give 
him  a  net  profit  of  $5000.  But  since  he  can  control  the  supply, 
he  will  limit  his  output  to  2,500,000  units,  giving  him  the  maxi- 
mum net  return,  $25,000. 


202 


OUTLINES   OF   ECONOMICS 


Price 
per  Unit 

NOMBER 

Sales 

Total 
Earnings 

Variable 
Expenses 
per  Unit 

Total 
Variable 
Expenses 

Fixed 

Expenses 

Total 
Expenses 

Net 
Renenue 

$.IO 

600,000 

$  60,000 

$.03 

$   18,000 

$50,000 

$  68,000 

-$8,000 

.09 

800,000 

72,000 

•03 

24,000 

50,000 

74,000 

—    2,000 

.08 

1,200,000 

96.000 

•°3 

36,000 

50.000 

86,000 

+  10,000 

.07 

1 ,800,000 

126,000 

•°3 

54,000 

50,000 

104.000 

+  22,000 

.06 

2.500,000 

150,000 

•°3 

75,000 

50.000 

125,000 

+  25,000 

■05 

3,500.000 

175,000 

•03 

105,000 

50,000 

i55>°oo 

+  20,000 

.04 

5,500,000 

220.000 

•03 

165,000 

50,000 

215,000 

+  5,°°° 

But  the  case  assumed  here  is  in  many  ways  far  simpler  than 
the  cases  presented  by  real  life.  The  monopolist  may  not  be 
able  easily  to  hit  upon  just  the  price  that  will  yield  maximum 
net  profits.  He  may,  by  experimenting  a  little,  approach  more 
closely  to  it,  but  at  best  he  can  hardly  hope  to  reach  more  than 
an  approximate  maximum.  Or  it  may  be  that  the  monopoly 
is  one  in  which  the  price  is  fixed  by  custom  or  convenience  (as 
is  in  some  measure  true  of  street  railway  transportation),  so  that 
the  monopolist  can  vary  only  the  quality  of  the  commodity  or 
service  he  sells  at  the  established  price.  Moreover,  it  should  be 
noted  that  the  price  most  profitable  for  the  present  may  not 
prove  the  most  profitable  price  in  the  long  run.  The  monopolist 
may  choose  to  forego  some  of  his  possible  profits  this  year  in 
order  to  extend  the  field  of  demand  for  his  product  and  to  lay 
the  foundation  of  a  long-continuing  period  of  profitable  produc- 
tion. Furthermore,  in  view  of  the  possibility  of  the  public  reg- 
ulation or  public  ownership  of  his  business,  he  may  deem  it  ex- 
pedient not  to  arouse  public  hostility,  and  so  may  decide  to  sell 
at  a  price  lower  than  what  would,  for  the  time  being,  be  the  most 
profitable  price. 

The  Effect  of  a  Tax.  —  Our  numerical  illustration  may  be 
made  to  convey  a  lesson  regarding  the  influence  of  taxation  upon 
monopolies  and  monopoly  price.  Fixed  expenses  have  no  in- 
fluence in  determining  the  price.  If,  therefore,  a  fixed  tax, 
say  of  S5000  a  year,  were  to  be  laid  upon  this  monopoly,  it  would 
not  result  in  an  increase  of  price.     A  study  of  the  table  will  show 


MONOPOLY  203 

that  with  such  a  tax  the  net  revenue  at  price  .08  would  be  $5000 ; 
at  price  .07,  $17,000  ;  at  price  .06,  $20,000 ;  at  price  .05,  $15,000; 
at  price  .04,  nothing.  Thus  price  .06  will  still  be  the  point  of 
maximum  net  revenue,  and  hence  the  monopoly  price.  On  the 
other  hand,  a  variable  tax,  for  instance  a  tax  of  one  cent  per 
unit,  would  result  in  this  case  in  raising  the  monopoly  price.  In 
our  illustration,  such  a  tax  would  make  the  net  revenue  at  the 
price  .08,  —  $2000;  at  the  price  .07,  $4000;  at  the  price  .06, 
nothing ;  at  the  price  .05,  —  $15,000.  Thus,  though  the  monop- 
oly would  find  its  profits  greatly  curtailed  by  such  a  tax,  con- 
sumers would  be  compelled  to  pay  one  cent  more  per  unit  for  the 
monopoly  product.  The  possible  advantage  which  society 
might  draw  from  the  tax  would  therefore  be  wholly  or  in  part 
offset  by  the  increased  cost  of  the  commodity.  We  may  conclude, 
therefore,  that  fixed  taxes,  or  taxes  on  the  net  revenue  of  a  mo- 
nopoly, cannot  be  shifted  wholly  or  in  part  by  a  change  in  price ; 
while  taxe«  laid  in  proportion  to  the  amount  of  business,  since 
they  contribute  an  addition  to  the  variable  expenses,  may  be 
wholly  or  in  part  shifted  by  a  change  in  price. 

Relation  of  Demand  to  Monopoly  Price.  —  There  are  certain 
conditions  on  the  side  of  demand  which  have  a  decisive  influence 
in  determining  monopoly  price.  The  most  important  of  these 
is  the  degree  of  elasticity  of  the  demand  for  the  monopoly  prod- 
uct. Th-f  more  inelastic  the  demand  for  the  monopolized  commodity 
or  service,  the  higher  will  be  the  monopoly  price  which  will  yield 
the  greatest  net  returns.  If  a  commodity  is  a  necessity  of  life, 
and  is  so  habitually  consumed  that  people  cling  with  intensity 
to  it,  monopoly  will,  other  things  being  equal,  be  more  profitable 
than  if  the  commodity  were  one  which  consumers  thought  they 
could  easily  dispense  with.  This  helps  to  explain  why  salt  and 
tobacco  have  been  chosen  as  fit  objects  for  public  fiscal  monopo- 
lies. The  more  adequate  the  substitutes  for  a  commodity,  the 
smaller  will  be  the  opportunity  for  surplus  profits  which  a  monop- 
oly of  that  commodity  will  give.  Finally,  the  higher  the  general 
average  of  economic  well-being,  and  the  more  readily  money  is 
generally  expended,  the  higher  will  be  the  monopoly  price 
which  will  yield  the  largest  net  returns. 


204  OUTLINES  OF   ECONOMICS 

Thus  monopoly,  without  any  effort  of  its  own,  shares  in  the  in- 
creasing wealth  of  a  country,  and  absorbs  a  considerable  part  of 
it.  It  is,  for  example,  among  other  influences,  the  larger  wealth 
per  capita  and  the  greater  willingness  to  spend  freely  that  makes 
monopoly  more  profitable  in  the  United  States  than  in  Germany 
or  other  European  countries. 

Class  Price.  —  Thus  far  we  have  assumed  that  the  monopolist 
charges  one  uniform  price  and  sets  the  price  at  the  point  which 
yields  him  the  largest  net  returns.  But  it  is  obvious  that  his 
gains  will  be  increased  if  he  is  able  to  vary  his  price.  His  gains 
would  be  highest  if  he  could  charge  each  individual  that  price 
which  would  yield  the  largest  net  returns,  taking  into  account  the 
number  of  sales  and  profits  on  each.  A  rich  man  might  pay 
double  the  current  rates  for  gas  or  electric  light  without  dimin- 
ishing his  consumption  in  the  least.  But  in  the  case  of  any  large 
modern  business  it  is  obviously  impracticable  to  fix  a  price  for 
each  individual,  even  were  there  no  legal  difficulties  «n  the  way, 
as  there  are  in  the  case  of  the  great  monopolistic  businesses  such 
as  gas  and  electric  lighting  and  railway  transportation.  The 
next  best  thing  for  the  monopolist  is  to  divide  his  public  into 
classes,  and  to  charge  to  each  class  that  price  which  will  yield 
the  largest  net  returns.  In  the  table  already  given,  we  found 
that  six  cents  was  the  monopoly  price  on  the  hypothesis  of  one 
uniform  price,  but  obviously,  if  the  eight-cent  and  ™ven-cent 
prices  could  be  secured,  and  six  cents  reserved  as  a  price  for  sales 
that  could  not  be  made  at  eight  or  seven  cents,  the  profits  would 
be  still  higher.  This  gives  rise  to  what,  in  its  broad,  general 
terms,  we  call  class  price.  The  monopolist  seeks  in  every  pos- 
sible way  to  divide  his  community  into  classes  and  to  secure 
from  each  the  highest  possible  price.  We  observe  a  remarkable 
development  of  class  price  in  the  case  of  our  railways ;  and,  unless 
legal  obstacles  are  interposed,  this  development  will  doubtless 
go  still  farther.  We  have  special  trains  with  an  extra  charge. 
We  have  privately  owned  railway  coaches ;  our  drawing-rooms 
and  single  seats  in  "  parlor  cars  " ;  our  ordinary  first-class 
tickets ;  and  our  second-class  tickets,  the  purchasers  of  which 
frequently  ride  in  the  "  day  coach  "  with  the  first-class  passen- 


MONOPOLY  205 

gers.  Then  we  have  single  tickets,  fifty-trip  family  tickets, 
monthly  commutation  tickets,  etc.,  with  enormous  variations 
in  price.  We  may  go  farther  and  say  that  the  American  rail- 
way rate  system  of  "charging  what  the  traffic  will  bear  "  is  a 
consummate  example  of  monopoly  prices. 

Nor  need  it  be  supposed  that  in  all  its  ramifications  class  price 
is  a  bad  thing.  It  is,  when  ignorance  and  need  are  exploited  by 
a  special  high  price ;  frequently  it  works  well  when  an  attempt 
is  made  to  reach  a  class  of  limited  means  with  a  very  low  price, 
as  in  the  case  of  early  and  late  workingmen's  trains,  etc. 

Monopoly  price  will  vary  with  use  ako ;  and  this  is  one  special 
subhead  under  class  price,  and  may  be  designated  as  use  price. 
The  typical  instance  is  that  of  two  prices  sometimes  charged  for 
gas :  a  higher  when  it  is  used  for  illuminating  purposes ;  a  lower 
when  it  is  used  for  fuel. 

Monopoly  Price  High  Price.  —  It  is  often  said,  and  frequently 
even  in  judicial  decisions,  that  the  monopolist  can  charge  any 
price  that  he  pleases.  We  have  already  seen  that  this  is  not 
the  case.  The  law  of  monopoly  price  shows  that  the  price,  even 
in  the  case  of  monopoly,  is  determined  by  economic  forces.  It 
is  conceivable  that  there  may  be  cases  in  which  monopoly  price 
will  exactly  coincide  with  competitive  price,  although  the  prob- 
abilities would  be  against  a  frequent  coincidence  of  this  kind. 
There  are  also  cases  where  monopoly  price  may  be  even  lower 
than  competitive  price.  If  a  monopolist  should  be  able  to  effect 
great  savings  as  compared  with  the  expense  of  doing  business 
under  competition,  it  could  happen,  in  theory,  that  the  price 
which  would  yield  the  largest  net  returns  would  be  a  lower  price 
than  would  be  possible  under  competition.  Probably,  and  in 
fact  almost  certainly,  under  a  condition  of  competition,  letters 
could  not  be  carried  as  cheaply  as  they  are. 

Generally  there  are  strong  reasons  for  the  position  that  mo- 
nopoly price  is  high  price.  Monopoly  is  formed  for  the  sake  of 
gain.  Gain  may  be  secured  in  two  ways  by  monopoly:  first, 
through  economies  of  production ;  and  it  is  alleged  by  trust  pro- 
moters that  these  economies  are  a  chief  motive  in  their  activity. 
There  are  some  gains  of  this  kind,  but  what  their  magnitude 


206  OUTLINES  OF  ECONOMICS 

may  be  in  a  particular  case  is  highly  uncertain.  When  we  com- 
pare a  monopolistic  business  with  a  competitive  business  organ- 
ized on  such  a  scale  as  to  secure  the  maximum  of  efficiency,  the 
gains  of  competition  in  alertness  and  inventiveness,  stimulated 
by  rivalry,  have  recently  been  too  little  considered. 

The  principal  source  of  gain  in  monopoly  is  found  in  the  ability 
to  get  a  high  price.  In  confirmation  of  the  position  that  monop- 
oly price  is  high  price,  we  may  refer  to  history,  the  utterances  of 
which  seem  to  be  clear  and  distinct.  At  any  rate,  there  can  be 
no  doubt  that,  in  the  opinion  of  historians  who  have  treated  the 
subject,  monopoly  means  high  price.  Hume,  in  his  treatment  of 
monopoly  in  his  History  of  England,  speaks  of  the  price  of 
monopolized  articles  as  exorbitant,  and  cites  the  price  of  salt, 
the  price  of  which  had  been  raised  by  monopoly  tenfold  and 
even  more.  It  is  generally  conceded  that  in  most  cases  of  a 
government  monopoly  of  the  production  or  sale  of  salt  the  price 
has  been  so  extremely  high  as  to  be  a  real  popular  grievance ; 
and  it  is  generally  necessary  to  inflict  severe  penalties  to  pre- 
vent the  people  from  securing  the  salt  at  a  lower  price  from 
non-authorized  sources.  But  of  still  greater  significance  are  the 
results  of  the  investigations  of  the  Industrial  Commission  of 
the  United  States.  It  was  there  made  evident  that  when 
monopoly  appears  in  a  form  at  all  clear  and  well  defined,  the 
tendency  is  plain  to  increase  the  margin  between  the  prices  of 
finished  products  and  raw  materials.1 

The  courts  of  the  world  have  made  it  clear  in  their  judicial  ut- 
terances that  they  regard  monopoly  price  as  high  price ;  and,  as 
their  opinions  are  based  upon  cases  actually  brought  before  them, 
we  cannot  do  otherwise  than  attach  great  importance  to  their 
view. 

Wherever  commissions  have  been  formed  with  power  to  regu- 
late monopoly  price,  and  these  commissions  have  been  comprised 
of  independent  and  strong  men,  there  has  been  a  marked  tend- 
ency to  reduce  monopoly  price;  because  unregulated  monop- 

1  See  report  by  Professor  J.  W.  Jenks  on  "Industrial  Combinations  and  Prices," 
Report  of  the  Industrial  Commission,  Vol.  i,  pp.  30-57 ;  and  also  the  same  author's 
work,  The  Trust  Problem,  Chap.  viii. 


MONOPOLY 


207 


oly  price  has  very  often  been  found  to  be  excessive  and  unjust. 
The  opinions  of  the  Railroad  Rate  Commission  of  Wisconsin 
afford  many  illustrations.  This  Commission  has  authorized  a 
higher  price  in  a  few  cases,  but  generally  has  been  forced  to  lower 
prices,  although  in  a  notable  case  of  passenger  rates  it  did  not 
go  so  far  as  the  legislature  subsequently  did.  The  same  state- 
ment holds  true  in  large  measure  of  the  decisions  of  other  state 
public  utility  commissions  and  of  the  Interstate  Commerce 
Commission. 

Monopolies  and  the  Distribution  of  Wealth.  —  We  have  not 
the  precise  statistical  data  which  will  enable  us  to  state  the  exact 
influence  of  monopoly  upon  the  distribution  of  wealth.  We  have, 
however,  sufficient  data  to  warrant  the  opinion  that  the  high 
monopoly  prices  and  the  gains  resulting  from  the  exclusive  posi- 
tion of  the  monopolist  give  us  a  large  privileged  class  in  countries 
of  modern  civilization,  and  especially  in  the  United  States.  Even 
when  the  increment  of  price  is  comparatively  small,  it  has  large 
significance  in  the  case  of  the  sale  of  a  vast  number  of  units  of 
services  or  commodities.  The  difference  between  a  four-cent 
street-car  fare  and  a  five-cent  street-car  fare  may  not  appear  to 
be  great,  but  it  is  a  difference  of  25  per  cent  and  leads  to  an 
enormous  difference  in  earnings. 

All  the  many  investigations  that  have  been  made  recently  in 
various  lines  of  business  (especially  in  railways,  the  beef  industry, 
the  steel  industry,  coal  mining,  etc.)  point  to  monopoly  as  a 
prime  cause  of  the  so-called  swollen  fortunes  of  this  country. 
In  this  and  other  countries  some  histories  of  families  distin- 
guished for  wealth  have  been  written,  and  probably  few  if  any 
cases  could  be  found  in  which  some  monopoly  element  had  not 
entered.  Various  lists  of  rich  men  have  been  published,  among 
them  one  published  by  the  New  York  Sun  in  1855,  and  one 
published  by  the  New  York  Tribune  in  1892.  These  lists  can- 
not by  any  means  be  presumed  to  be  accurate,  and  yet  they  do 
afford  very  considerable  evidence  of  the  sources  of  large  for- 
tunes, and  point  to  monopoly  as  a  prime  source  of  the  enor- 
mous fortunes  of  today.  This  is  a  subject  which  in  itself  would 
require  a  larger  book  than  the  present  one  for  adequate  treat- 


208  OUTLINES  OF   ECONOMICS 

ment.  The  student  should  attempt  by  observation  and  study 
to  carry  forward  the  lines  of  investigation  and  thought  here 
suggested. 

Public  Policy  with  Respect  to  Monopolies.  —  As  many  mo- 
nopolies have  come  as  a  result  of  underlying  laws  of  industrial 
evolution,  they  cannot  all  be  abolished.  Experience,  and  the 
analysis  of  industries  like  railways,  gas  works,  etc.,  falling  under 
the  head  of  "  public  utilities,"  so  called,  should  be  conclusive. 
We  must  have  monopoly  in  these  cases,  and  the  only  question 
we  are  concerned  with  is,  "  What  kind  of  monopolies  shall  we 
have  ?  "  We  must  admit  that  unregulated  monopolies  in  private 
hands  have  always  been  odious  and  are  opposed  to  the  principles 
of  the  laws  of  civilized  nations.  They  are  opposed  to  that 
endeavor  to  secure  equality  of  opportunity  which  is  fundamental 
in  modern  democracy  and  which  manifests  itself  as  a  red  thread 
running  through  American  history.  Even  George  Washington, 
generally  looked  upon  as  calm  and  self-contained,  denounced 
monopolizers  and  wished  they  might  be  "  hunted  down  as  pests 
of  society  "  and  "  hanged  on  a  gallows  live  times  higher  than  the 
one  prepared  for  Haman."  l  It  is  not  so  much  high  price  that 
disturbs  the  modern  man  as  it  is  inequality  of  opportunity ;  and 
this  general  sentiment  has  been  very  clearly  and  forcibly  ex- 
pressed in  court  decisions.  In  the  field  in  which  monopoly  is 
natural  and  inevitable,  therefore,  we  cannot  permit  unregulated 
special  privilege,  and  to  this  end  we  must  choose  between  pub- 
lic monopoly  —  government  ownership  —  and  public  control  of 
monopolies  privately  owned  and  operated.  This  opens  up  so 
vast  a  subject  for  discussion  that  we  cannot  enter  into  it  here. 
It  should  be  noted,  however,  that  the  considerations  which  must 
govern  our  choice  differ  for  different  types  of  natural  monopolies. 
Municipal  waterworks  and  the  federal  post  office  are  in  most 
respects  efficiently  and  successfully  managed.  But  in  the  case 
of  many  other  natural  monopolies  the  problems  of  management 
are  more  complex  and  difficult  in  many  ways.  Just  now  the 
method  of  public  control  rather  than  of  public  ownership  is  be- 
ginning to  be  given  a  thorough  test.     Our  policy  in  the  future 

1  C.  J.  Bullock,  Essays  on  the  Monetary  History  of  the  United  States,  p.  67. 


MONOPOLY  209 

will  undoubtedly  be  determined  in  large  measure  by  the  results 
of  that  test.  Public  control,  to  secure  equality  of  opportunity, 
must  so  regulate  monopolies  and  limit  price  that  the  gains  will 
be  no  higher  than  those  produced  by  equally  wise  investments 
and  equally  wise  and  prudent  management  in  the  field  of  com- 
petition.1 Sometimes  it  is  stated  that  owners  of  railways  and 
other  monopolistic  enterprises  should  have  a  competitive  return 
upon  all  the  money  that  they  have  invested.  This  would  give 
them  a  position  of  special  privilege,  inasmuch  as  in  the  competi- 
tive field  a  great  deal  of  money  is  lost.  It  is  only  wise  invest- 
ment and  careful  management  in  the  field  of  competition  that 
can  secure  returns  equal  or  superior  to  the  current  rates  of  in- 
terest. Imprudently  invested  capital  is  lost  in  the  field  of  com- 
petition ;  and  when  it  is  imprudently  and  unwisely  invested  in 
the  field  of  monopoly,  it  cannot  justly  claim  any  return. 

When  we  turn  to  the  field  of  social  monopolies  we  find  that  the 
problems  of  public  control  are  simpler,  but  more  diverse.  These 
monopolies  exist  only  by  the  approval  or  tolerance  of  society, 
and  each  particular  one  can  be  judged  on  its  own  merits.  The 
problem  of  social  monopolies,  therefore,  resolves  itself  into  such 
problems  as  those  of  the  economic  effects  of  the  patent  system, 
the  best  way  of  controlling  the  consumption  of  liquors  and 
other  harmful  commodities,  and  the  most  expedient  means  of 
raising  public  revenues.     With  respect  to  one  class  of  social 

1  This  does  not  mean  that  in  the  case  of  old  enterprises  price  must  always  be  so 
reduced  that  the  gains  shall  yield  a  competitive  return  only  on  the  physical  value 
of  a  plant.  The  principle  of  vested  rights  or  interests  has  to  be  given  a  certain 
r61e.  These  have  often  been  created  by  society  rather  than  by  private  persons,  and 
faith  must  be  kept.  In  the  case  of  railways  and  the  telegraph,  the  American  nation 
and  states  have  deliberately  encouraged  a  wasteful  policy  of  competition  which 
is  in  large  measure  responsible  for  high  capitalization.  It  would  not  be  right 
to  place  upon  holders  of  these  properties  all  the  burdens  of  a  mistaken  public  policy 
in  the  past.  What  is  needed  is  to  declare  a  public  policy  for  the  future  and  to  base 
returns  for  the  future  upon  future  actual  investments  in  the  case  of  public  utilities. 
In  any  case,  our  federal  and  state  governments  are  acting  wisely  in  insisting  upon 
physical  valuations  of  railways,  gas  works,  and  other  similar  monopolies  as  a  help 
in  determining  fair  prices  for  present  and  future.  Now  and  here  we  can  do  no  more 
than  to  throw  out  these  suggestions  in  regard  to  a  pressing  present  problem  of  great 
magnitude.  A  further  discussion  of  some  aspects  of  the  problem  will  be  found  in 
Chap.  XXVII  (Transportation). 


2IO  OUTLINES   OF   ECONOMICS 

monopolies  society  has  reached  a  very  definite  conclusion :  There 
must  be  no  needless  extension  of  the  field  of  monopoly  through 
either  public  or  private  favoritism.  The  possibility  of  obtaining 
monopoly  through  special  privilege  is  clearly  inconsistent  with 
the  maintenance  of  equal  opportunity  in  the  industrial  field. 

The  problem  of  the  public  control  of  monopoly  is  sometimes 
confused  with  the  "  trust  problem  "  —  the  problem  of  the  public 
control  of  large  industrial  combinations.  But  the  trust  problem 
is  only  in  part  a  problem  of  monopoly.  It  will  be  discussed  in 
the  following  chapter. 

QUESTIONS  AND  EXERCISES 

i .  Has  bigness  anything  to  do  with  monopoly  ?  Do  you  know  any  small 
business  which  is  a  monopoly  ?  Do  you  know  any  very  large  business  which 
is  keenly  competitive?  Contrast  a  state  of  competition  with  a  state  of 
monopoly. 

2.  Define  monopoly  and  discuss  each  point  in  the  definition. 

3.  Contrast  land  ownership  with  monopoly. 

4.  Explain  the  importance  of  classification  of  monopolies,  and  especially 
of  distinguishing  between  private  and  public  monopolies,  and  social  and 
natural  monopolies. 

5.  State  the  main  classes  of  monopolies,  and  give  the  divisions  and  sub- 
divisions in  each  class. 

6.  A  public  tobacco  monopoly  exists  in  France  and  produces  large  rev- 
enues. The  business  is  generally  said  to  be  well  managed.  Do  you  see 
any  benefits  that  would  accrue  from  the  establishment  of  such  a  monopoly  in 
the  United  States  ?  any  evil  effects  ? 

7.  Define  monopoly  price  and  show  how  it  is  determined. 

8.  What  does  class  price  mean?    Explain  use  price. 

9.  Why  do  we  think  of  monopoly  price  as  high  price  ?  Do  you  know  any 
monopoly  price  which  is  a  low  price?  What  do  you  mean  by  high  price? 
by  low  price  ? 

10.  What  relation  has  monopoly  to  large  fortunes?  to  small  fortunes? 
What,  if  any,  to  poverty? 

n.   What  is  the  best  public  policy  with  respect  to  monopolies? 

REFERENCES 

Brown,  W.  J.     The  Prevention  and  Control  of  Monopolies. 

Ely,  R.  T.    Monopolies  and  Trusts,  Chaps,  i-iv. 

Hobson,  J.  A.     Evolution  of  Modern  Capitalism,  revised  ed.,  Chap.  ix. 


MONOPOLY  211 

Levy,  Hermann.    Monopoly  and  Competition. 

Marshall,  Alired.    Principles  of  Economics,  6th  ed.,  Book  v,  Chap.  xiv. 

Pigou,  A.  C.     Wealth  and  Welfare,  Chaps,  ix-xiii. 

Price,  W.  II.     The  English  Patents  of  Monopoly. 

Taussig,  F.  W .    Principles  of  Economics,  Vol.  i,  Chap.  xv. 

United  States  Industrial  Commission.  Report,  Vols,  i  and  ii. 


CHAPTER  Xm 
BUSINESS   ORGANIZATION 

The  Meaning  of  "  Business."  —  The  dominance  of  "  busi- 
ness "  in  our  present  social  economy  is  so  familiar  and  common- 
place a  thing  that  we  are  apt  to  forget  its  real  significance. 
"  Business  "  means  profit  seeking.  It  does  not  cover  so  broad 
a  field  as  does  "  production,"  nor  is  it  quite  the  same  thing  as 
"  production  for  the  market."  Business  is  acquisitive  rather 
than  productive,  and  while  acquisition  usually  involves  produc- 
tion, this  is  not  invariably  the  case.  Business  operations  con- 
sist, fundamentally,  in  buying  or  hiring  things  and  in  selling 
them  or  using  them  for  the  purpose  of  gaining  a  profit.  Among 
the  things  thus  bought  or  hired  are  land,  labor,  capital  goods, 
and  business  privileges  or  advantages,  such  as  franchises,  patents, 
copyrights,  and  "  good-will."  The  economic  world,  in  its  busi- 
ness aspect,  is  a  world  of  buying  and  selling  rather  than  of  making 
and  using  things ;  it  is  a  world  in  which  prices,  expenses,  debts 
and  credits,  and  contractual  relations  are  the  dominating  things 
rather  than  the  technical  processes  of  production  or  the  ultimate 
costs  of  production  as  measured  in  human  effort  and  sacrifice. 
Commerce  and  manufactures  have  each  in  turn  been  brought 
under  the  dominion  of  business  enterprise ;  business  methods  and 
motives  are  also  of  the  first  importance  in  agriculture,  although 
in  this  last  field  production  for  home  use  continues  hand  in  hand 
with  production  for  profit. 

The  Nature  of  Business  Units.  —  The  business  world  is  made 
up  of  profit-seeking  units,  —  entrepreneurial  units.  We  are  apt 
to  think  of  business  units  as  composed  of  individual  men  or 
groups  of  men.  In  an  ultimate  sense  this  is  not  incorrect,  but 
for  present  purposes  we  may  more  profitably  view  business  units 


BUSINESS   ORGANIZATION 


21S 


as  merely  the  centers  or  foci  of  the  contractual  and  other  rela- 
tions that  bind  the  business  world  together.  These  relations  are 
recorded  and  stated  more  or  less  fully  in  the  accounts  of  each 
business  unit ;  ultimately,  however,  they  are  matters  of  legal 
fact,  and,  as  we  shall  see,  the  legal  aspect  and  the  accounting 
aspect  of  these  relations  are  not  always  identical. 

The  Business  Unit  in  Accounting.  —  The  simplest  general 
way  in  which  a  business  unit  can  be  described  by  its  accounts 
is  by  means  of  the  balance  sheet,  which  is  the  statement  of  the 
assets  or  resources  and  the  liabilities  or  obligations  of  the  busi- 
ness unit  as  they  exist  at  a  particular  time.  The  following  is  a 
simplified  form  of  balance  sheet  for  a  small  manufacturing 
establishment : 


Assets 

Land  and  buildings  .  .  $190,000 
Machinery  and  fixtures  .  50,000 
Raw   materials,   goods  in 

process,      and      finished 

goods  on  hand        .     .     .      40,000 

Accounts  receivable        .     .      28,000 

Cash  on  hand  and  in  banks         7,000 

Total  assets  ....  $315,000 


Liabilities 

Original  capital  invested  .  $200,000 
Income  reinvested  .  .  .  70,000 
Accounts  payable  .  .  .  20,000 
Profits 25,000 


Total  liabilities 


$315,000 


The  itemized  assets  explain  themselves,  but  the  meaning  of 
the  various  liabilities  may  not  be  so  clear.  In  this  statement  all 
the  items  of  the  liabilities  except  "  accounts  payable  "  are  liabil- 
ities of  the  business  unit,  conceived  as  a  separate  thing,  to  its 
owner  or  owners,  —  the  amount  which  would  be  left  if  the 
business  were  sold  as  a  whole  at  a  price  just  equal  to  the  total 
estimated  value  of  the  assets  minus  the  actual  outstanding  obli- 
gations (the  accounts  payable).1  It  will  be  noted  that  the  item 
called  "  profits  "  is  the  variable  by  which  the  account  is  bal- 
anced. 

1  The  form  of  balance  sheet  given  in  the  text  is  a  simple  adaptation  of  the  kind 
of  balance  sheet  used  in  the  published  statements  of  corporation  accounting.  But 
if  the  individual  proprietor  of  a  small  business  keeps  an  accurate  ledger  account 
with  himself,  the  result  is  the  same  so  far  as  the  independence  of  the  business  as  an 
accounting  unit  is  concerned. 


214  OUTLINES  OF   ECONOMICS 

On  such  a  showing  as  this  the  owners  might  decide  to  take  $5000  out  of 
the  business  as  dividends,  or  personal  profits,  as  the  case  may  be.  This 
would  reduce  the  "cash"  to  $2000  and  correspondingly  reduce  "profits." 
They  might  decide,  also,  permanently  to  retain  $10,000  of  their  earnings 
in  the  business.  "Profits"  would  then  be  reduced  to  $10,000,  and  the 
"income  reinvested"  would  be  increased  to  $80,000.  In  the  case  of  cor- 
porations the  "original  investment"  item  is  called  "capital"  and  repre- 
sents the  par  or  nominal  value  of  the  corporation's  stocks  and  bonds,  whether 
or  not  the  corporation  has  received  this  amount  in  return  for  them.  Sur- 
plus profits  in  such  cases  can  be  easily  converted  into  "capital"  by  means 
of  "stock  dividends." 

The  business  unit  is  pictured  in  the  balance  sheet  as  the  owner 
of  various  kinds  of  valuable  property  and  of  valuable  claims 
against  those  indebted  to  it.  But  on  the  other  hand,  as  the 
balance  sheet  also  shows,  there  are  rights  or  claims  of  equal 
amount  against  the  business  unit  on  the  part  of  its  own  creditors 
and  proprietors.  The  liabilities  side  of  the  balance  sheet  shows 
how  the  ultimate  rights  or  equities  in  the  property  and  credits 
shown  as  assets  are  distributed  among  creditors  and  proprietors. 
The  business  unit,  as  a  thing  apart  from  its  proprietors,  has 
only  an  imaginary  existence.  But  it  is  convenient  to  think 
of  it  as  having  valuable  rights  or  assets  of  its  own,  and  to  think 
of  the  claims  against  these  rights  as  being  distributed  in  the  form 
of  obligations  or  liabilities.  This  explains  the  statement  that 
business  units  are  the  centers  or  foci  of  business  relations. 

In  its  legal  aspect,  however,  the  business  does  not  always  have 
so  distinct  a  unity  of  its  own.  This  varies  with  the  form  of 
business  organization,  of  which  there  are  three  important 
types:  the  individual  entrepreneur,  the  partnership,  and  the 
corporation. 

The  Individual  Entrepreneur.  —  Any  individual  may  set  him- 
self up  as  a  business  man,  an  entrepreneur,  without  any  legal 
formality  other  than  the  payment  of  the  license  fee  which  most 
states  impose  on  some  kinds  of  business  undertakings,  such  as 
liquor  dealing,  and  which  some  states,  especially  in  the  South, 
impose  upon  many  kinds  of  undertakings.  The  individual  en- 
trepreneur still  dominates  the  field  in  agriculture,  in  small  retail 
trade,  and  in  local  "  shop  industries." 


BUSINESS   ORGANIZATION  215 

In  the  legal  aspect  the  obligations  of  a  business  conducted  by 
an  individual  entrepreneur  are  the  personal  obligations  of  the 
entrepreneur.  All  of  his  possessions  —  of  whatever  kind l  —  are 
jeopardized  by  his  business  risks.  If  the  entrepreneur  conducts 
two  distinct  business  undertakings,  the  assets  of  one  may  be 
seized,  if  necessary,  to  secure  the  liabilities  of  the  other.  The 
personal  liability  of  the  individual  entrepreneur  is  accordingly 
said  to  be  unlimited.  The  usefulness  of  this  kind  of  business 
organization  is  limited,  obviously,  to  small  undertakings,  where 
the  capital  and  credit  of  the  individual  man  are  adequate. 

Partnerships.  — A  "  firm  "  or  partnership  represents  a  joint 
undertaking  by  individual  entrepreneurs.  Partnerships  are 
most  common  in  mercantile  undertakings  of  moderate  size,  in 
small  manufacturing  establishments,  and  in  the  professions. 
This  joining  of  interests  makes  larger  undertakings  possible,  but 
relatively  increases  the  personal  liability  of  the  individual  mem- 
bers of  the  firm.  For  each  member  is  personally  liable  for  all  of 
the  obligations  contracted  by  the  firm,  including  those  contracted 
in  the  ordinary  course  of  business  by  any  other  one  member  of 
the  firm.2  The  partners  may  have  a  contract  binding  among 
themselves  as  to  their  respective  contributions  (of  money  or 
time),  shares  in  profits,  and  liabilities.  But  a  member  released 
from  personal  liability  by  an  agreement  of  this  kind  is  still  liable 
for  all  obligations  incurred  by  the  firm.  The  agreement  only 
gives  a  basis  for  instituting  legal  proceedings  to  recover  the 
amount  of  his  personal  losses  from  the  other  members  of  the  firm. 

Aside  from  (1)  the  excessive  personal  liability  involved,  the 
partnership  is  open  to  objection  from  the  business  man's  point 

1  The  "exemption  laws"  of  some  states  constitute  an  exception  which  does 
not  affect  the  principle  involved. 

2  This  refers  to  the  status  of  the  ordinary  partnership  under  common  law.  The 
statutes  of  most  of  the  states  provide  for  a  special  form  of  limited  partnership,  in 
which  one  or  more  of  the  partners  are  special  partners,  who  are  not  personally 
liable,  save  for  their  investment  in  the  business,  and  who  are  allowed  to  take  no 
active  part  in  the  management  of  the  business.  In  a  few  states  there  Ls  a  special 
form  called  a  limited  partnership  association,  in  which  the  liability  of  all  the  partners 
is  limited.  These  are  practically  joint-stock  companies  with  non-transferable 
shares.  The  partnership  in  commendam,  which  still  exists  in  Louisiana  as  a  heritage 
of  the  civil  law,  is  essentially  like  the  statutory  limited  partnerships  of  other  states. 


216  OUTLINES  OF  ECONOMICS 

of  view,  because :  (2)  It  is  impossible  for  a  partner  to  retire  from 
a  firm  without  dissolving  the  partnership  and,  possibly,  break- 
ing up  the  business.  The  death  or  insolvency  of  any  partner  has 
the  same  effect.  (3)  A  new  member  cannot  enter  the  firm  nor 
can  a  member  transfer  his  interests  to  another  person  without 
the  consent  of  all  the  members  of  a  firm,  —  requirements  which 
naturally  follow  from  the  nature  of  a  partnership.  (4)  The 
partnership  form  of  organization  is  not  adapted  to  undertakings 
requiring  large  investments  of  capital  and  hence  requiring  the 
cooperation  of  a  large  number  of  persons.  What  advantages  the 
partnership  has  come  from  the  ease  with  which  it  can  be  organ- 
ized and  dissolved,  and  from  its  elasticity,  —  that  is,  the  ease 
with  which  the  contractual  relations  among  the  partners,  bind- 
ing as  among  themselves,  can  be  altered  to  suit  any  contingencies 
that  may  arise. 

The  Business  Corporation.  —  The  federal  census  of  1909 
showed  that,  although  only  about  one  fourth  of  the  manufactur- 
ing undertakings  included  in  that  enumeration  were  organized 
as  corporations,  yet  these  produced  nearly  four  fifths  of  the  total 
manufacturing  product  (measured  in  money  value).  Most 
banks  and  insurance  companies  are  corporations,  while  in  the 
field  of  railway  transportation  corporations  are  in  almost  exclu- 
sive control.  And  a  large  and  growing  number  of  mercantile 
undertakings  are  organized  as  corporations. 

In  the  case  of  the  corporation  the  legal  view  and  the  account- 
ing view  of  the  business  unit  are  practically  identical.  While 
the  ordinary  partnership  is  in  law  merely  a  group  of  individual 
entrepreneurs,  the  corporation  is  regarded,  for  some  purposes,  as 
a  "  person."  To  the  incorporated  business  unit,  —  an  abstract 
thing,  as  we  have  seen,  —  the  law  imputes  some  of  the  attributes 
of  personality,  —  and  of  a  personality  distinct  from  that  of  the 
individual  men  who  are  the  stockholders  of  the  corporation.1 

1  Several  states  authorize  the  organization  of  "  joint-stock  companies  "  which 
are  like  corporations  in  many  particulars.  In  theory  they  are  partnerships  with 
■Transferable  shares  and  (in  some  cases)  with  limited  liability.  Joint-stock  com- 
panies are  also  organized  under  the  common  law  in  some  states.  In  England  and 
the  English  colonies  the  name  "  joint-stock  company  "  is  applied  to  a  statutory' 


BUSINESS  ORGANIZATION  217 

Municipalities,  universities,  monasteries,  guilds,  etc.,  were  commonly 
incorporated  by  royal  charter  long  before  business  corporations  of  the 
modern  kind  arose,  —  for  this  did  not  occur  until  the  rise  of  "capitalism" 
in  the  sixteenth  and  seventeenth  centuries.  The  great  trading  and  coloniz- 
ing companies,  such  as  the  British  East  India  Company,  the  Virginia  Com- 
pany, the  Guinea  Company,  etc.,  were  the  prototypes  of  the  modern  business 
corporation.  In  connection  with  these  trading  companies  the  joint-stock 
principle,  which  had  already  been  used  in  a  few  isolated  instances  of  banking, 
was  developed.  This  was  the  practice  of  issuing  certificates  to  those  who 
made  contributions  to  the  "joint  stock"  (or  capital)  of  a  company,  which 
entitled  the  holder  to  a  proportionate  share  in  the  profits  accruing  to  the 
joint  stock.  The  modern  business  corporation,  like  these  early  trading 
companies,  is  based  essentially  on  the  combination  of  the  joint-stock  prin- 
ciple with  the  legal  recognition  of  the  business  unit  as  a  distinct  entity. 

At  the  beginning  of  the  nineteenth  century  what  few  corporations  there 
were  in  America  were,  for  the  most  part,  banks,  insurance  companies,  or 
canal  and  turnpike  companies.  The  introduction  of  railways  in  the  third 
decade  of  the  century  greatly  stimulated  the  organization  of  corporations, 
because  these  new  undertakings  required  larger  investments  of  capital  than 
could  be  furnished  by  any  individual  or  firm.  State  enterprise,  it  is  true, 
promised  at  one  time  to  be  an  important  factor  in  canal  and  railway  building, 
but  such  state  undertakings  were  usually  planned  with  the  purpose  of  de- 
veloping natural  resources,  attracting  immigration,  and  building  up  the 
trade  of  particular  districts  and  particular  cities  rather  than  of  getting  money 
profits.  Most  of  these  state  undertakings  had  succumbed  by  1840,  so  that 
the  field  was  left  open  for  business  enterprise.  In  the  general  expansion  and 
reorganization  of  business  that  followed  the  Civil  War  the  corporation  form 
of  organization  began  to  be  more  generally  used  for  all  kinds  of  business 
undertakings.  The  growing  importance  of  corporations  in  business  life  is 
partly  an  effect  and  partly  a  cause  of  the  growing  size  of  the  business  unit. 

The  Corporation  Charter.  —  The  corporation  is  a  creature  of 
the  state,  its  right  to  exist  being  dependent  on  a  charter  or  on 
articles  of  incorporation,  granted  or  approved  by  the  state.  In- 
corporation formerly  necessitated  a  special  act  of  the  legislature 
in  each  case.  This  gave  opportunity  for  favoritism  and  monop- 
oly and  subjected  corporations  of  all  kinds  to  hostility  and 
suspicion.  Most  corporations  are  now  organized  under  general 
laws,  whereby   any  group  of   men    can  secure  a  corporation 

limited-liability  association,  essentially  like  the  American  business  corporation, 
while  the  word  "  corporation  "  is  usually  applied  only  to  municipal  corporations 
and  certain  long-established  companies,  created  by  special  charters. 


2l8  OUTLINES  OF  ECONOMICS 

charter  by  complying  with  certain  prescribed  conditions.  In 
fact,  all  but  six  states  now  have  constitutional  provisions 
against  the  granting  of  charters  to  business  corporations  by 
special  act. 

It  was  formerly  a  common  practice  to  grant  corporation  char- 
ters in  perpetuity,  but  the  decision  of  Chief  Justice  Marshall  in 
the  Dartmouth  College  case  (1819),  whereby  the  corporation 
charter  was  declared  to  constitute  a  binding  contract  between  the 
state  and  the  corporation,  which  could  not  be  altered  or  amended 
by  the  state  except  with  the  consent  of  the  corporation,  has  led  to 
the  general  practice  of  limiting  the  life  of  corporations  to  terms 
of  from  twenty  to  one  hundred  years,  fifty  years  being  a  common 
period.  The  corporation  may,  of  course,  secure  a  new  charter 
at  the  expiration  of  the  old,  but  the  limited  term  gives  the 
state  the  opportunity  to  change  the  requirements  of  the 
charter  from  time  to  time,  or  to  refuse  reincorporation  alto- 
gether, as  may  seem  most  desirable.  Most  states,  moreover, 
now  specifically  reserve  the  right  to  alter  or  amend  the  corpora- 
tion charter  at  pleasure. 

Corporation  charters,  or  articles  of  incorporation,  usually  con- 
tain details  relating  to  such  matters  as  the  purpose  or  purposes 
for  which  the  corporation  is  formed,  its  principal  place  of  busi- 
ness, the  number  of  its  directors,  and  the  amount  of  its  capitali- 
zation. 

Lack  of  Uniformity  in  State  Laws.  —  Many  difficulties  in  the 
public  control  of  corporations  have  arisen  from  the  fact  that 
while  charters  are  granted  by  individual  states,  the  activities  of 
many  business  corporations  extend  over  the  boundaries  of  many 
states.  Moreover,  some  states  are  much  more  lenient  than 
others  in  such  matters  as  the  control  of  capitalization,  require- 
ments as  to  publicity,  limitations  on  the  scope  of  activity  of  a 
single  corporation,  taxes  and  fees,  etc.  New  Jersey  has  become 
known  as  the  "  home  of  corporations  "  despite  the  fact  that  some 
states  have  had  even  more  lenient  laws  than  New  Jersey.  New 
Jersey  has  been  favored,  however,  on  account  of  the  proximity 
of  New  York  City  —  the  real  home  of  most  of  the  greater  cor- 
porate interests  of  the  country  —  as  well  as  on  account  of  its 


BUSINESS  ORGANIZATION  219 

early  start  and  the  adaptability  of  its  laws  to  great  combinations 
of  corporations.1 

Other  states,  with  stricter  laws,  could  not  prevent  corporations 
organized  under  lax  laws  from  doing  business  within  their  terri- 
tory so  far  as  that  business  is  interstate.  So  far,  however,  as  a 
corporation  organized  under  the  laws  of  one  state  carries  on  any 
part  of  its  business  wholly  within  the  borders  of  another  state, 
the  latter  state  has  the  right  of  refusing  to  recognize  it  as  a  cor- 
poration ;  that  is,  the  right  to  treat  it  as  a  mere  partnership.  In 
practice,  however,  one  state  freely  recognizes  the  corporations  of 
another  state  under  the  rule  of  "  interstate  comity."  In  fact, 
many  corporations  transact  practically  all  of  their  business  out- 
side the  borders  of  the  state  which  chartered  them.  The  real 
standards,  therefore,  are  the  laxest  standards,  not  the  highest. 
More  use  on  the  part  of  American  states  of  the  power  of  exacting 
certain  standards  from  "  foreign  corporations,"  as  they  are 
called,  is  much  to  be  desired. 

Corporation  Capital  and  Capitalization.  —  The  business  world 
uses  the  term  "  capital  "  in  two  ways.  It  speaks  of  the  total 
permanent  investments  —  the  amount  of  money  "tied  up"  in  a 
business  unit  —  as  its  capital.  This  is  the  better  and  more 
common  usage.  But  it  also  speaks  of  the  total  selling  value  of 
the  business  unit  as  a  whole  as  its  capital.  This  last  will  depend 
not  so  much  upon  the  amount  of  the  investment  as  upon  its 
profitableness.  It  is  roughly  measured  by  the  "  capitalized  " 
earning  capacity  of  the  business,  or  by  the  market  value  of  the 
corporation's  stock  and  bonds. 

The  capitalization  of  a  corporation  should  not  be  confused  with 
its  capital.  In  a  strictly  legal  sense  its  capitalization  is  the 
amount  of  its  authorized  capital  stock.  The  capitalization  cor- 
responds, in  theory,  to  the  amount  of  money  actually  invested 
in  the  business  by  the  original  stockholders.  As  a  matter  of 
fact,  the  full  amount  of  the  authorized  capital  is  rarely  paid  in  at 
the  organization  of  a  new  corporation.  The  capitalization  is 
apt  to  be,  in  practice,  a  somewhat  arbitrary  thing,  —  a  nominal 

1  In  igi3  the  corporations  laws  of  New  Jersey  were  revised  so  that  they  offer 
fewer  advantages  to  large  corporations  than  they  previously  did. 


220  OUTLINES   OF   ECONOMICS 

money  sum  divided  into  units  or  shares,  the  relative  holdings  of 
different  individuals  being  measured  by  the  number  of  shares 
they  own. 

Corporation  stock  is  divided  into  two  general  classes,  —  pre- 
ferred stock  and  common  stock,  although  many  corporations  issue 
only  the  latter.  Preferred  stock  represents  a  prior  claim  on  the 
earnings  of  the  corporation.  A  corporation  which  has  "  6  per 
cent  preferred  stock  "  outstanding  can  pay  no  dividends  to  its 
common  stockholders  until  it  has  paid  6  per  cent  dividends  on 
its  preferred  stock.  Preferred  stock  may  be  cumulative  (in  which 
the  prior  claims  to  dividends  accumulate  from  year  to  year,  if 
unpaid)  or  non-cumulative.  It  may  or  may  not  have  any  claim 
on  any  part  of  the  surplus  profits  remaining  after  a  stated  rate 
of  dividend  has  been  paid  on  the  common  stock. 

In  the  popular  use  of  the  word  the  capitalization  of  a  corpora- 
tion includes  also  its  funded  debt.  The  funded  debt  is  represented 
by  bonds,  which  are  interest-bearing  promises  to  pay  certain  sums 
of  money  at  definite  times  in  the  future.  There  are  many  differ- 
ent kinds  of  bonds,  but  three  principal  classes  are :  (i)  ordinary 
mortgage  bonds,  (2)  collateral  trust  mortgage  bonds,  (3)  income 
and  debenture  bonds.  The  first  class  is  based  on  a  mortgage 
of  all  or  of  a  specific  part  of  the  real  property  of  a  corporation. 
Collateral  trust  mortgage  bonds  are  secured  by  the  pledge  of 
securities  issued  by  other  corporations,  but  owned  by  the  corpo- 
ration issuing  the  bonds.  They  have  been  much  used  in  financ- 
ing railway  consolidations.  Income  and  debenture  bonds  are 
usually  secured  only  by  the  earning  capacity  of  the  business. 
Industrial  corporations  make  less  use  of  bonds  than  do  railways, 
and  confine  themselves  usually  to  the  mortgage  bond  type,  — 
of  which,  however,  there  are  many  subordinate  varieties.  In 
the  case  of  many  corporations  the  mortgage  security  behind  an 
issue  of  bonds  is  in  itself  not  of  great  importance,  for  the  property 
mortgaged  is  apt  to  be  worthless  except  as  an  integral  part  of  a 
unified  business  establishment.  The  mere  power  of  foreclosure, 
however,  gives  mortgage  bondholders  a  position  of  strength 
in  the  reorganization  of  insolvent  corporations. 

Bonds  are  sometimes  said  to  represent  "  creditor  interests," 


BUSINESS   ORGANIZATION  221 

and  stock  "  proprietorship  interests."  This  statement  is  sug- 
gestive and  is  not  inaccurate.  In  a  more  general  sense,  however, 
stock  and  bonds  are  merely  different  kinds  of  equities  in  a  busi- 
ness unit,  —  conveying  the  right  to  receive  income,  to  share  in 
the  distribution  of  the  assets  in  case  of  insolvency,  and  to  have  a 
voice  in  the  management.  Stockholders  alone  participate  in 
the  management  of  the  corporation,  although  bondholders 
are  often  able  to  dictate  policies  when  the  affairs  of  a  corporation 
are  in  a  precarious  condition.  Bonds  differ  from  stock  in  being 
terminable  at  a  definite  period  of  time  in  the  future.  In  practice, 
however,  the  bonds  of  great  corporations  are  usually  replaced 
by  new  issues  as  rapidly  as  they  mature. 

Overcapitalization.  —  Much  has  been  said  about  the  over- 
capitalization of  corporations,  —  "  stock  watering,"  as  it  is 
called.  Only  a  few  states  require  that  all  the  nominal  capitaliza- 
tion of  corporations  organized  under  their  laws  shall  represent 
capital  actually  invested.  In  most  states,  moreover,  it  is  not 
difficult  for  a  corporation  to  increase  its  capitalization  from 
time  to  time  so  as  to  secure  funds  from  the  sale  of  securities, 
or  (as  in  the  case  of  stock  dividends)  in  order  to  afford  a  basis 
for  the  distribution  of  surplus  profits  without  employing  an 
excessively  high  dividend  rate. 

On  the  one  hand  it  is  urged  that  capitalization  is  a  nominal 
thing,  that  it  is  immaterial  whether  a  corporation  pays  12  per 
cent  dividends  on  $1,000,000  of  capital  stock  or  6  per  cent 
dividends  on  $2,000,000  of  capital  stock.  On  the  other  hand  it 
is  said  that  capitalization  should  not  be  a  merely  nominal  thing, 
but  that  it  should  correspond  to  the  actual  amount  of  the  invest- 
ment; that,  without  regard  to  the  amount  of  capitalization, 
regularly  recurring  dividends  of  12  per  cent  suggest  excessive 
profits  in  a  way  that  6  per  cent  dividends  do  not. 

The  argument  in  favor  of  a  closer  correspondence  between 
capitalization  and  real  investment  is  especially  strong  in  the 
case  of  railways  and  other  transportation  corporations  with 
quasi-public  functions,  municipal  public  service  corporations, 
and  corporations  enjoying  natural  monopolies  of  all  kinds.  For 
there  is  a  growing  feeling  that  such  corporations  are  in  a  peculiar 


222  OUTLINES  OF   ECONOMICS 

sense  social  trustees,  to  whom  have  been  committed  certain 
public  economic  functions  that  might  very  properly  be  per- 
formed by  the  State,  if  that  course  were  deemed  the  more  advan- 
tageous. That  such  corporations  should  be  restricted  to  the 
payment  of  a  reasonable  dividend  on  reasonable  capitalization 
would  seem  scarcely  to  be  open  to  question.1  Yet  excessive 
profits  are  what  make  excessive  dividends  possible,  and  whether 
profits  are  excessive  or  not  can  be  determined  in  most  cases 
without  reference  to  capitalization  by  the  compulsory  use  of 
adequate  accounting  methods.  Even  where  accounting  methods 
used  in  the  past  have  been  inadequate,  the  amount  of  the  in- 
vestment entitled  to  a  return  can  usually  be  determined  with 
rough  accuracy  by  means  of  a  "valuation"  or  appraisal  of  a 
company's  properties,  coupled  with  an  examination  of  the  prin- 
cipal facts  of  its  financial  history.  There  is  a  growing  use  of 
this  method  on  the  part  of  both  federal  and  state  governments. 

There  is  a  prevalent  but  entirely  mistaken  belief  that  over- 
capitalization is  often  the  cause  of  exorbitant  charges.  It  is 
thought  that  the  desire  to  pay  dividends  on  an  inflated  capitali- 
zation leads  corporations  to  exact  a  higher  return  for  their  prod- 
ucts or  their  services  than  they  otherwise  would.  But  it  can 
easily  be  seen  that  such  cannot  often  be  the  case.  For  whether 
its  capitalization  be  high  or  low  the  corporation  will  desire  to 
fix  its  charges  at  the  level  which  will  yield  the  greatest  possible 
profits.  The  magnitude  of  the  corporation's  capitalization  will 
have  no  bearing  upon  the  determination  of  the  most  profitable 
level  of  charges.  The  charges  which  would  be  most  profitable 
under  a  low  capitalization  will  also  be  the  most  profitable  under 
a  high  capitalization. 

A  weightier  indictment  of  overcapitalization  is  that  it  has 
opened  the  door  to  a  number  of  reprehensible  practices  in  cor- 
poration promotion  and  management.  Where  there  is  no  defi- 
nite correspondence  between  capitalization  and  investment  it 
is  difficult  to  make  sure  that  some  persons  will  not  be  able  to 
acquire  the  securities  of  a  given  corporation  on  much  easier 

1  It  is  better  to  curtail  excessive  profits  by  public  control  of  rates,  prices,  and 
services  than  by  arbitrarily  limiting  the  dividend  rate. 


BUSINESS  ORGANIZATION  223 

terms  than  others.  Overcapitalization  al./ays  makes  available, 
for  example,  what  may  be  termed  a  surplus  of  stock,  and  this 
surplus,  instead  of  being  distributed  equally  among  the  differ- 
ent stockholders,  may  be  used  in  a  disproportionate  and  extrava- 
gant payment  to  the  promoter  (or  organizer)  of  the  corporation, 
or  the  bankers  who  have  assisted  in  marketing  its  securities. 
Or  a  group  of  men  in  control  of  a  corporation  may  reap  an  unfair 
advantage  at  the  expense  of  other  security  holders  by  turning 
over  to  the  corporation  properties  of  which  they  themselves  are 
the  owners  in  return  for  an  exorbitant  amount  of  the  corpora- 
tion's securities.  Operations  of  this  kind  have  only  too  fre- 
quently attended  the  organization  of  great  industrial  combina- 
tions in  this  country.  American  railway  history,  also,  is  full  of 
examples  of  extravagant  sums  paid  by  operating  companies  to 
"  construction  companies  "  which  had  been  organized  for  the 
purpose  of  building  the  roads  and  selling  them  to  the  operating 
companies.  These  payments  were  usually  made  in  bonds  or 
stock,  and  burdened  the  operating  company  with  either  a  heavy 
load  of  fixed  charges  or  an  inflated  amount  of  capital  stock.  In 
fact,  the  time  is  not  long  past  when  it  was  frequently  said  of 
representative  American  railroads  that  the  whole  amount  of 
the  actual  investment  in  their  properties  was  represented  by 
their  bonded  debt,  while  their  stock  issues  represented  nothing 
but  prospective  surplus  earnings.  In  the  promotion  of  industrial 
combinations  it  was  common  practice  to  issue  enough  preferred 
stock  to  cover  the  actual  expense  of  acquiring  the  various  proper- 
ties brought  into  the  consolidation  and  to  issue  in  addition  a 
large  amount  of  common  stock  representing  nothing  except 
whatever  increase  in  earning  power  might  result  from  combina- 
tion. The  common  stock,  at  whatever  price  it  could  be  sold, 
represented,  in  fact,  the  profits  of  promotion ;  and  these  usually 
went  to  promotors  and  other  "  insiders."  In  both  the  railway 
and  industrial  field,  however,  conditions  are  much  improved. 
In  many  cases  large  additional  investments  have  been  made  out 
of  earnings  without  a  corresponding  increase  in  capitalization ; 
in  certain  other  cases  corporations  have  been  reorganized, 
with  reduced  capitalization.     But,  nevertheless,  there  are  recent 


224  OUTLINES  OF   ECONOMICS 

instances  of  unfair  and  even  fraudulent  use  of  excessive  capitali- 
zation as  a  means  of  securing  special  profits  for  those  in  control 
of  a  corporation's  policies.1 

The  situation  is  clearly  one  that  needs  mending.  Two  very 
different  methods  of  regulation  have  been  proposed.  The  first 
of  these  two  methods  involves  the  definite  limitation  of  a  cor- 
poration's capitalization  to  an  amount  corresponding  to  the 
sum  of  money  actually  received  by  the  corporation  and  invested 
in  its  business.  If  securities  are  issued  in  exchange  for  property 
turned  over  to  the  corporation  or  for  services  rendered  it,  a  full 
account  must  be  rendered  of  all  of  the  circumstances  attending 
such  transactions,  and  an  official  appraisal  of  their  value  may 
even  be  required.  Such,  in  general,  have  been  since  1884  the 
conditions  under  which  joint-stock  companies  in  Germany  issue 
their  shares,  and  it  does  not  appear  that  these  requirements  have 
hindered  the  organization  or  growth  of  such  companies  in  that 
country. 

Under  the  second  method  of  regulation,  corporations  are  left 
free  to  issue  their  securities  in  such  quantities  as  they  deem  best, 
it  being  required  merely  that  publicity  shall  be  given  to  the 
prices  at  which  the  securities  are  sold,  to  the  price  placed  upon 
any  property  or  services  paid  for  in  securities,  and  to  the  disposi- 
tion made  of  all  money  obtained  by  the  issue  of  securities.  This 
kind  of  regulation  is  adopted,  in  principle,  in  the  British  Com- 
panies Act,  but  the  mechanism  provided  to  enforce  it  is  not  very 
effective.  At  best,  however,  even  the  most  thoroughgoing 
publicity  respecting  the  conditions  under  which  securities  are 
issued  cannot  be  a  wholly  adequate  safeguard  against  the  real 
evils  of  over-capitalization.  Publicity  might  tend  to  curb  ex- 
travagant allowances  for  personal  services,  but  it  would  not  al- 
ways prevent  the  overvaluation  of  large  properties  taken  in 
exchange  for  securities.  To  think  otherwise  is  to  count  too 
much  upon  the  knowledge  and  alertness  of  the  individual  stock- 
holder. Certain  American  railroads  have  openly  paid  exorbi- 
tant prices  for  branch  lines  and  other  properties,  without  re- 

1  See  the  special  reports  of  the  Interstate  Commerce  Commission  on  the  St. 
I-ouis  and  San  Francisco  and  the  New  York,  New  Haven,  and  Hartford  railroads. 


BUSINESS  ORGANIZATION  225 

ceiving  any  protests,  at  the  time,  from  stockholders  and  creditors 
injuriously  affected  by  these  transactions. 

We  have  done  very  little  in  the  United  States  in  the  regulation 
of  the  capitalization,  or  the  other  conditions  of  promotion,  of 
ordinary  industrial  corporations.  Some  states,  however,  now 
exercise  a  fairly  rigid  control  over  the  new  security  issues  of  rail- 
ways and  other  public  service  corporations.  This  regulation, 
however,  does  not  have  as  its  primary  motive  the  protection  of 
minority  stockholders.  It  is  to  be  interpreted  as  part  of  a  gen- 
eral attempt  to  limit  the  earnings  of  such  corporations  to  a  fair 
return  upon  a  reasonable  capitalization. 

It  has  been  suggested  1  that  in  order  to  guard  against  the  very  prevalent 
misunderstanding  of  the  real  nature  of  corporation  shares,  the  "  dollar  mark  " 
should  not  appear  on  them,  or,  in  other  words,  that  they  should  have  no  "par 
value."  They  would  then  become,  in  form  as  in  fact,  merely  certificates  of 
the  ownership  of  certain  fractional  equities  in  a  corporation's  business. 
There  is  much  that  is  attractive  about  this  proposal.  If  the  issue  of  securi- 
ties is  to  be  as  unregulated  as  it  has  been  in  the  past,  it  would  be  better  to 
make  it  impossible  for  investors  and  the  general  public  to  attach  any  ficti- 
tious importance  to  the  amount  of  a  corporation's  capitalization.  But  if 
we  are  to  have  the  regulation  of  promotion  and  capitalization  that  we  need, 
there  would  be  nothing  gained  by  the  change  suggested.  And  the  "dollar 
mark"  on  stock  certificates  is  convenient  in  many  ways. 

Form  of  Capitalization.  —  A  significant  feature  of  recent  de- 
velopment in  corporation  finance  is  the  multiplicity  of  types  of 
corporate  securities.  It  is  no  uncommon  thing,  for  example,  for 
the  equities  in  a  railway  corporation  (in  addition  to  the  floating 
debt,  or  accounts  payable)  to  be  divided  among  a  dozen  or 
twenty  varieties  of  bonds  and  two  or  three  varieties  of  stock. 
This  multiplicity  of  securities  is  of  advantage  to  the  corporation 
in  that  it  enables  it  to  offer  to  investors  and  speculators  a  care- 
fully graded  assortment  of  risks,  and  this  makes  the  total  selling 
value  of  a  corporation's  securities  greater  than  it  would  other- 
wise be.  This  complex  kind  of  capitalization  has,  however,  some 
undesirable  features.  If  the  owners  of  a  particular  security — 
the  common  stockholders,  perhaps  —  control  the  corporation, 

1  Most  recently  by  the  very  able  federal  Railroad  Securities  Commission  of  191 1. 
The  state  of  New  York  now  permits  the  issue  1  f  corporate  shares  without  par  value. 


226  OUTLINES   OF   ECONOMICS 

they  may  desire  to  increase  the  value  of  their  securities  for  specu- 
lative purposes  by  the  payment  of  unearned  dividends,  —  a  pro- 
ceeding which  would  be  opposed  to  the  interests  of  the  holders 
of  all  the  other  securities  of  the  corporation.  Or  the  holders  of 
preferred  stock  may  wish  to  put  some  of  the  earnings  of  the  cor- 
poration back  into  improvements  in  its  plant,  so  as  to  safeguard 
its  future  earning  capacity,  while  the  holders  of  common  stock 
may  prefer  that  all  the  earnings  he  paid  out  in  dividends.  More- 
over, in  cases  of  insolvency  and  reorganization,  it  is  a  difficult 
matter  to  untangle  and  to  adjust  equitably  the  rights  of  the 
holders  of  the  different  kinds  of  securities. 

In  times  of  prosperity  corporations  often  pay  for  extensions  of 
their  plants  from  the  proceeds  of  bond  sales,  because  it  is  esti- 
mated that  the  earning  power  of  such  extensions  will  more  than 
suffice  to  pay  the  interest  on  the  bonds  and  will  afford  a  hand- 
some surplus  for  the  stockholders.  Corporations  thus  accumu- 
late in  prospeious  times  an  unwieldy  load  of  fixed  charges  in  the 
form  of  interest  on  bonds,  —  a  fact  which  is  apt  to  be  a  source 
of  difficulty  in  less  prosperous  years.  In  periods  of  financial 
stringency  these  fixed  charges  are  a  common  cause  of  insolvency, 
receiverships,  and  consequent  reorganizations,  from  which  the 
bondholders  are  apt  to  emerge  as  stockholders,  and  in  which 
the  stockholders  are  apt  to  lose  their  holdings.  The  legal  restric- 
tion of  the  securities  issued  by  any  one  corporation  to  one  kind 
of  stock  and  three  or  four  varieties  of  bonds  is  both  feasible  and 
desirable.  Nor  should  the  bonded  debt  usually  be  allowed  to 
exceed  the  amount  of  the  paid-up  capital  stock. 

Corporation  Management.  — The  management  of  business  cor- 
porations is,  as  a  rule,  in  the  hands  of  boards  of  directors,  elected 
by  the  stockholders  from  among  their  own  number.  The  details 
of  management  are  in  the  hands  of  officers,  chosen  usually  by  the 
directors.  In  principle  this  system  achieves  something  like  rep- 
resentative government  of  the  affairs  of  the  corporation.  In 
practice,  in  t^e  larger  corporations,  some  of  the  directors  are  apt 
to  be  "  dummy  directors,"  —  men  exercising  no  real  power  or 
responsibility,  made  directors  in  order  to  complete  the  number 
prescribed  in  the  charter,  —  or  are  the  representatives  of  great 


BUSINESS   ORGANIZATION  227 

financial  interests,  and  often  of  competing  interests.  Directors 
of  this  latter  sort  are  not  primarily  concerned  with  the  manage- 
ment  of  a  corporation  in  the  interests  of  its  stockholders  and 
bondholders.  They  are  directors  for  the  purpose  of  guarding 
special  interests,  and  in  many  cases  for  the  purpose  of  preventing 
competition  from  becoming  anything  more  active  than  an  armed 
peace.  In  some  cases  the  real  direction  of  a  corporation's 
policies  is  in  the  hands  of  an  "  executive  committee  "  or  "  finance 
committee  "  of  three  or  more  directors  representing  the  person 
or  persons  in  actual  control  of  the  corporation. 

The  proper  adjustment  of  the  rights  and  duties  of  the  various 
members  of  a  corporation  is  a  matter  of  general  public  concern. 
This  is  partly  because  the  shares  in  a  corporation  are  freely  trans- 
ferable. A  new  member  cannot  protect  himself  by  making 
special  contracts  with  the  other  members,  but  must  accept  the 
conditions  fixed  by  the  by-laws  of  the  corporation  and  by  the 
laws  of  the  state  which  chartered  it.  Moreover,  the  ordinary 
shareholder  in  a  large  corporation  has  little  opportunity  to  par- 
ticipate in  any  way  in  the  conduct  of  the  affairs  of  the  corpora- 
tion, even  for  the  purpose  of  protecting  his  own  interests.  The 
general  theory  upon  which  the  law  of  corporations  is  based  is 
that  the  corporation  is  a  democracy  with  a  representative  gov- 
ernment. That  is,  the  directors  are  supposed  to  represent  the 
interests  of  the  stockholders.  For  many  small  local  corpora- 
tions this  theory  undoubtedly  corresponds  fairly  well  with  the 
facts.  But  large  corporations,  with  hundreds  or  thousands  of 
stockholders,  living  in  different  parts  of  the  country,  and  even 
in  different  countries,  cannot  accurately  be  pictured  as  rep- 
resentative democracies.  Outside  of  a  group  of  holders  of 
large  blocks  of  stock,  the  stockholders,  whether  a  minority 
or  a  scattered  majority,  are  likely  to  be  not  only  powerless  but 
voiceless.  It  is  dimcu1 1  and  probably  undesirable  to  change 
this  general  situation.  The  growth  of  large  corporations 
means  necessarily  the  growth  of  widespread  participation  in 
large  business  undertakings.  But  the  participators,  whether 
stockholders  or  bondholders,  are  to  be  regarded  as  investors 
rather  than  active  partners.     What  is  needed  in  our  corporation 


228  OUTLINES  OF   ECONOMICS 

statutes,  therefore,  is  a  frank  recognition  of  this  situation.  In 
many  cases  directors  cannot,  in  any  real  way,  "  represent  "  the 
stockholders.  For  this  reason  their  responsibility  as  trustees 
for  the  stockholders  should  be  emphasized  in  our  laws.1 

Advantages  of  the  Corporation  as  a  Form  of  Business  Organ- 
ization. —  From  the  point  of  view  of  the  business  man  the  cor- 
poration presents  decided  advantages  over  the  partnership  for 
all  undertakings  of  considerable  size.  Some  of  its  points  of 
superiority  are :  (i)  Stockholders  usually  have  no  personal  lia- 
bility for  the  corporation's  obligations  except  so  far  as  the  full 
par  value  of  their  stockholdings  has  not  been  paid  up.2  (2)  The 
relative  permanence  and  stability  of  the  corporation  are  of  de- 
cided advantage,  especially  in  undertakings  requiring  large  in- 
vestments of  capital  in  relatively  fixed  and  permanent  forms. 
(3)  The  concentration  of  executive  power  in  the  hands  of  direc- 
tors and  officers  leads  to  efficiency  in  management.  (4)  The 
transferability  of  corporation  securities  makes  it  possible  foi 
stockholders  to  enter  or  leave  the  undertaking  at  pleasure. 
(5)  The  division  of  the  securities  into  small  units  and  into  differ- 
ent grades  and  classes  affords  opportunities  to  all  kinds  of  inves- 
tors, —  the  small  and  the  large,  the  conservative  and  the  ven- 
turesome. (6)  All  of  the  advantages  named  make  it  easier  for 
the  corporation  to  attract  and  to  use  efficiently  large  amounts  of 
capital,  furnished  by  many  different  investors. 

Social  Aspects  of  the  Growth  of  Corporations.  —  That  corpora- 
tions do  possess  desirable  features,  from  the  point  of  view  of 


1  On  this  account  the  recent  development  of  "express  trusts"  as  business  or- 
ganizations, especially  in  Massachusetts,  is  of  j  articular  interest.  The?e  have 
"trust  deeds"  in  place  of  articles  of  incorporation,  "trustees"  in  place  of  directors, 
and  "benencdaries"  in  place  of  stockholders.  In  simplicity,  adaptability,  and  in 
the  protection  of  investors  and  creditors,  this  form  of  business  organization  has 
some  real  advantages  over  the  corporation.  But  it  has  not  yet  been  subjected  to 
adequate  public  control,  and  there  are  some  minor  difficulties  in  its  working.  It 
may  prove  to  be,  however,  the  germ  of  an  important  development  in  business  or- 
ganization. 

*  Exception  should  be  made  of  banking  and  insurance  corporations,  in  the  case 
of  which  "double  liability"  on  the  part  of  the  stockholders  is  common.  A  few 
states  impose  some  measure  of  personal  liability  upon  the  stockholders  of  all 
corporations  organized  under  their  law*. 


BUSINESS   ORGANIZATION  229 

business  interests,  is  a  fact  clearly  evidenced  by  the  unprece- 
dented growth  of  this  form  of  business  organization.  In  the 
main,  efficiency  for  business  purposes,  for  money-making,  means 
efficiency  from  the  social  point  of  view,  productive  efficiency  also. 
But,  nevertheless,  the  two  points  of  view  are  not  identical,  and 
what  is  desirable  from  one  point  of  view  is  not  always  desirable 
from  the  other. 

The  gap  between  money-making  and  service  to  society  (never 
quite  identical  things)  is  distinctly  widened  when  those  in  control 
of  a  corporation's  policies  subordinate  the  profits  to  be  obtained 
by  the  sale  of  its  products  to  the  profits  to  be  obtained  by  specu- 
lation in  its  securities.  Many  of  our  greatest  corporations  are 
directed  by  men  to  whom  fluctuations  in  capital  values  (as  repre- 
sented in  the  prices  of  securities)  are  a  much  more  important 
source  of  personal  income  than  are  the  net  earnings  of  such 
corporations.  The  payment  of  unearned  dividends,  the  non- 
payment of  earned  dividends,  the  direction  of  a  corporation's 
policy  for  the  benefit  of  the  holders  of  one  kind  of  security  among 
the  different  ones  issued  by  the  corporation,  the  effecting  of  cor- 
porate combinations  and  reorganizations  that  will  affect  the  stock 
exchange  rather  than  the  produce  market,  —  these  are  some  of 
the  more  obvious  results  of  the  unfortunate  relation  between  cor- 
poration management  and  speculation  in  corporation  securities. 

It  should  also  be  noted  in  this  connection  that  the  growth  of 
corporations  is  bringing  with  it  a  subtle  but  very  significant 
change  in  the  nature  of  the  institution  of  private  property.  So 
far  as  a  large  and  increasing  proportion  of  productive  wealth  is 
concerned,  we  are  losing  that  direct  relation  of  ownership  be- 
tween men  and  goods  which  Arthur  Young  had  in  mind  when  he 
said,  "  The  magic  of  property  turns  sand  into  gold."  We  often 
have,  instead,  several  layers  of  corporation  securities  interposed 
between  the  ultimate  owners  and  the  ultimate  objects  of  owner- 
ship. The  effect  of  this  will  undoubtedly  be  to  bring  about  the 
more  thorough  domination  of  business  principles  in  the  business 
world.  Sentiment,  the  honored  traditions  of  long-established 
firms,  the  "  pride  of  ownership,"  the  joy  of  workmanship  (which 
may  be  felt  by  the  employer  who  turns  out  a  good  product,  as 


230  OUTLINES  OF  ECONOMICS 

well  as  by  the  workman)  are  bound  to  yield  yet  more  completely 
to  the  sway  of  the  cold  logic  of  corporation  accounts  and  stock 
market  quotations.  The  adequacy  of  purely  business  principles 
as  the  foundation  of  our  economic  life  will  be  tested  more  thor- 
oughly under  the  corporation  form  of  organization  than  ever  be- 
fore. 

Trusts.  —  A  distinctive  feature  of  the  economic  development 
of  the  past  few  decades  has  been  the  combination  of  individual 
corporations  into  larger  concerns,  or  trusts.  The  "  trust,"  in  the 
technical  sense,  involved  either  giving  a  board  of  trustees  the 
absolute  control  of  the  actual  properties  of  the  different  con- 
cerns in  the  combination,  or  what  amounted  to  the  same  thing, 
assigning  to  them  the  stock  of  each  corporation,  with  its  voting 
power,  in  exchange  for  "  trust  certificates,"  on  which  dividends 
were  paid.  The  Standard  Oil  Trust  of  1882  was  the  first  impor- 
tant combination  of  this  kind,  but  it  was  speedily  followed  by 
several  others.  In  1890,  in  a  case  brought  by  the  state  of  New 
York  against  the  sugar  trust,  the  trust  agreement  was  held  to  be 
illegal  under  common  law.1  Corporate  combinations  were  not 
destroyed  by  this  decision.  They  changed,  however,  to  a  more 
definitely  coherent  form,  —  that  in  which  a  single  great  corpora- 
tion dominates  the  consolidation. 

In  most  cases,  this  corporation,  which  is  usually  organized 
for  the  purpose,  does  not  own  the  actual  plants  of  the  various 
concerns  in  the  combination,  but  simply  owns  all  or  a  majority  of 
the  stock  of  each.  It  is  accordingly  called  a  "  holding  company." 
The  holding  company  exchanges  its  own  securities  for  the  securi- 
ties of  constituent  companies,  or,  when  necessary,  it  buys  the 
securities  of  the  constituent  companies  with  funds  secured  from 
the  sale  of  its  own  securities,  —  sometimes  by  the  sale  of  bonds 
secured  by  the  pledge  of  the  securities  of  constituent  companies 
as  collateral.     Not  only  in  industrial  consolidations,2  but  also  in 

1  People  v.  North  River  Sugar  Refining  Co.,  121  N.  Y.  582.  A  similar  decision 
was  rendered  two  years  later  by  the  Supreme  Court  of  Ohio  in  State  v.  Standard 
Oil  Co.,  49  Ohio  St.  137. 

1  A  very  complete  list  of  "trusts,"  prepared  by  Mr.  Byron  W.  Holt  for  the  World 
Almanac  (1008),  contained  the  names  of  abou*  ~,'n  'ndustrial  combinations,  most 
of  which  were  holding  companies. 


BUSINESS  ORGANIZATION  231 

railway  and  electric  railway  mergers  has  the  holding  company 
device  become  important. 

From  the  point  of  view  of  business  organization  the  holding 
company  is  simply  an  extension  of  the  principle  of  the  corpora- 
tion. The  holding  company  needs  for  purposes  of  control  only 
a  majority  interest  in  the  stocks  of  its  subsidiary  corporations. 
Various  holding  companies  may  in  turn  be  combined  by  means 
of  one  larger  holding  company,  and  the  process  may,  and  does, 
go  even  further.  A  group  of  capitalists  may,  by  an  investment 
of  $1,000,000,  for  example,  control  a  holding  company  with 
a  stock  issue  of  $2,000,000,  which  in  turn  may  control  corpora- 
tions with  $4,000,000  of  stock  outstanding,1  —  and  some  of 
these  last  may  in  their  turn  be  holding  companies.  The  result 
is  a  tremendous  concentration  of  industrial  and  financial  power, 
with  the  minimum  of  liability.  The  uncontrolled  use  of  the 
holding  company  device  leads  to  neglect  of  the  interests  oi  the 
minority  stockholders  in  the  various  corporations  concerned ;  to 
difficulty  in  fixing  the  legal  responsibility  for  corporate  mis- 
deeds ;  to  an  undesirable  complexity  in  the  economic  and  legal 
relations  of  the  holders  of  securities  in  the  different  corporations, 
and  to  the  subordination  of  industrial  to  speculative  ends. 

The  '"  trust  problem,"  however,  has  attracted  more  attention 
as  a  problem  of  monopoly  than  as  a  problem  of  business  organiza- 
tion. Combination  and  monopoly,  it  is  important  to  note,  are 
not  identical  things ;  we  may  have  either  one  without  the  other. 
But  the  movement  toward  combination  originated  in  the  efforts 
of  business  men  to  escape  from  the  restraints  imposed  upon  them 
by  competition.  Use  has  often  been  made  of  simpler  forms  of 
combination  than  the  trust  and  the  holding  company.  Agree- 
ments to  sell  only  at  certain  prices,  agreements  to  limit  output, 
the  employment  in  common  of  one  selling  agent,  pooling  (the 
distributions  of  orders  or  of  profits  to  the  parties  to  the  agree- 
ment in  predetermined  proportions),  and  other  devices   have 

1  It  is  assumed,  for  convenience,  that  the  stock  in  each  case  is  worth  par  and 
that  the  ownership  of  half  of  it  will  give  substantial  control.  In  the  case  of  indus- 
trial combinations  ownership  of  all  the  stock  of  the  subsidiary  companies  by  the 
holding  company  is  not  uncommon. 


232  OUTLINES  OF   ECONOMICS 

been  used.  Such  combinations  are  formed  by  contracts  entered 
into  by  a  number  of  individual  firms,  each  of  which  retains  its 
own  autonomy  in  all  other  respects.  These  contracts  are  un- 
enforceable at  common  law  —  being  held  to  be  "contracts  in 
restraint  of  trade  "  and  hence  contrary  to  public  policy  —  so  that 
it  was  difficult  to  be  sure  that  any  one  firm  would  abide  by  the 
contract  any  longer  than  it  deemed  it  to  be  to  its  own  individual 
advantage.  Combinations  of  this  sort  still  persist.  Railroad 
rate  agreements  are,  for  example,  both  universal  and  necessary. 

But  the  movement  toward  combination  which  has  played  so 
important  a  part  in  the  economic  history  of  the  past  thirty  years 
has  been  characterized  especially  by  the  organization  of  combina- 
tions of  a  more  thoroughly  unified  type,  in  which  each  individual 
firm  brought  into  the  combination  yields  up  its  own  autonomy 
and  is  absorbed  by  a  corporation,  usually  a  holding  company, 
organized  for  the  purpose.  These  unified  combinations,  it  was 
thought,  would  be  valid  at  common  law,  and  would  be  less 
vulnerable  under  the  new  anti-combination  statutes  that  were 
being  enacted.  Their  management  could  be  made  more  effec- 
tive, and  their  comparative  permanence  and  dependability 
made  possible  the  adoption  of  business  policies  based  on  long- 
time considerations.  Moreover,  so  long  as  there  was  public 
confidence  in  their  success,  they  afforded  an  inviting  opportunity 
for  promoters  to  reap  profits. 

The  Causes  of  Combination.  —  The  specific  motives  usually 
mentioned  as  the  most  important  causes  of  corporate  combina- 
tions are  (i)  the  economies  of  large-scale  business;  (2)  the 
elimination  of  purely  competitive  expenses  (some  kinds  of  ad- 
vertising, for  example) ;  (3)  the  power  to  limit  output  and  con- 
trol prices. 

The  first  of  these  factors  suggests  the  difficult  question  of  the 
most  profitable  size  of  the  business  unit.  The  question  should 
not  be  confused  with  that  of  the  most  economical  size  of  the 
industrial  plant.  Many  of  our  present-day  business  units  are 
so  large  that  they  operate  a  number  of  practically  duplicate 
plants.  To  that  extent,  at  least,  they  are  larger  than  is  necessary 
to  secure  the  maximum  technical  efficiency  of  the  plant.     Nor 


BUSINESS  ORGANIZATION  233 

should  the  question  be  confused  with  that  of  the  factors  which 
bring  about  the  condition  of  decreasing  expenses  in  an  industry 
at  large.  Certain  productive  advantages  sometimes  attributed 
to  great  industrial  combinations  —  such  as  the  power  of  utilizing 
highly  specialized  plants,  equipped  with  highly  specialized  ma- 
chinery and  located  at  the  most  favorable  points  —  are  advan- 
tages which  do  not  have  to  wait  upon  combination,  but  which  are 
not  only  available  but  certain  to  be  developed  in  any  large  and 
growing  competitive  industry.  Much  has  been  said  of  the  com- 
bination's ability  to  buy  its  raw  materials  on  the  largest  scale,  and 
therefore  most  cheaply,  and  of  its  ability  to  ship  its  products  in 
large  quantities,  and  therefore  most  economically.  But  it  has 
not  been  shown  that  the  combination  has  a  marked  advantage 
in  these  particulars  over  large  competitive  establishments, 
unless  we  should  take  account  of  the  unfair  discriminations  that 
railway  companies  have  too  often  made  in  favor  of  the  large 
combinations. 

The  real  problem  is  whether  the  mere  fact  of  combination, 
taken  by  itself,  brings  with  it  any  real  net  economies  in  produc- 
tion. It  probably  very  often  happens  that  combination  does 
effect  some  real  savings.  Uniform  systems  of  accounting  and 
cost-keeping  can  be  introduced ;  noteworthy  economies  found  in 
any  one  of  the  plants  can  be  introduced  in  all  the  plants  of  the 
same  type ;  high  and  uniform  standards  can  be  enforced  by  the 
central  administration.  Especially  in  combinations  of  the 
"  integrated  "  type,1  there  are  undoubtedly  real  economies  in 
the  general  coordination  of  the  different  successive  stages  of  the 
industrial  process,  in  the  nice  adjustment  of  the  supply  of  raw 
materials  and  intermediate  products  to  the  demand  for  finished 
products,  and  in  the  adaptation  of  transportation  facilities  to 
the  needs  of  the  industry.  The  Standard  Oil  Company  un- 
doubtedly effected  great  economies  in  the  transportation  of  oil 
by  its  use  of  pipe  lines,  and  these  could  hardly  have  been  con- 
structed on  so  large  and  effective  a  scale  if  the  industry  had  re- 
mained competitive. 

On  the  other  hand,  however,  great  combinations  have  certain 

1  See  p.  88,  above. 


234  OUTLINES  OF  ECONOMICS 

disadvantages  inseparable  from  their  size.  Their  economies 
are  largely  those  of  systematization  and  standardization,  and 
these  are  prone  to  degenerate  into  inflexible  and  deadening 
routine.  The  very  losses  of  competition  may  sometimes  be  in 
the  long  run  a  real  social  advantage.  ¥or  they  result  in  part 
from  variety  of  experimentation  and  from  the  free  scope  given 
to  individual  initiative  and  individual  planning.  In  competitive 
industry  there  is  a  continuing  natural  selection  of  the  fittest  men 
and  the  fittest  methods.  Nor  are  the  best  results  always 
achieved  by  a  hierarchical  organization  of  industry,  in  which 
corporation  officials,  managers,  and  superintendents  watch 
only  over  the  larger  and  more  general  aspects  of  an  industry 
and  depend  upon  an  army  of  subordinate  employees  (no  matter 
how  scientifically  organized  and  directed)  to  attend  to  all  de- 
tails. There  is  sometimes  no  effective  substitute  for  intimate 
personal  supervision  on  the  part  of  those  primarily  responsible 
for  the  success  or  failure  of  a  business  undertaking. 

Passing  to  the  second  and  third  general  classes  of  motives 
that  are  advanced  as  causes  of  corporate  combinations,  it  is  suffi- 
cient here  to  note  that  whether  purely  competitive  expenses  and 
competitive  prices  are  eliminated  by  combination  depends  upon 
whether  the  combination  has  any  real  basis  of  monopoly  power 
over  and  above  the  mere  fact  of  combination,  which,  taken  alone, 
can  give  at  most  only  a  temporary  monopoly.  For  a  combina- 
tion without  some  real  source  of  monopoly  power  to  attempt 
to  secure  monopoly  profits  is  to  invite  new  enterprise  and  new 
capital  to  come  into  the  industry.  In  other  words,  it  is  to  induce 
latent  competition  to  become  active  competition. 

It  is  plain,  however,  that  if  any  or  all  of  these  three  classes  of 
advantages  do  exist  in  the  case  of  a  particular  combination,  the 
earning  power  of  the  combination  will  be  greater  than  the  total 
earning  power  of  the  separate  concerns  before  consolidation,  — 
a  difference  which  will  be  reflected  in  the  value  of  the  securities 
of  the  holding  company.  It  is  this  increment  in  capital  value, 
due  to  the  real  or  expected  advantages  of  consolidation,  that  has 
been  the  chief  cause  of  such  combinations.  The  organization  of 
trusts  has  in  many  cases  been  effected  by  professional  pro- 


BUSINESS  ORGANIZATION  235 

moters,  whose  connection  with  an  undertaking  does  not  con- 
tinue any  longer  than  is  necessary  in  order  to  secure  the  profits 
of  consolidation.  A  few  great  trusts  like  those  which  have 
figured  in  the  oil,  sugar,  steel,  and  tobacco  industries  have  been 
conspicuously  successful  in  a  business  way.  Many  others  were 
"  made  to  sell  "  ;  that  is,  were  organized  only  in  order  that  profits 
might  be  gained  through  the  sale  of  their  securities,  and  have 
been  weighted  down  by  a  capitalization  not  justified  by  their 
actual  earning  capacity.  Some  of  these  have  already  fallen  to 
pieces ;  others  have  been  reorganized,  with  diminished  capitaliza- 
tion. 

"  When  judged  in  terms  of  the  promises  of  their  promoters  their  histories 
stand  as  striking  acknowledgments  of  the  inadequacy  of  mere  consolidation 
as  a  basis  of  economic  efficiency.  Two  separate  and  distinct  sets  of  causes 
can  be  discovered  to  explain  why  the  overwhelming  majority  of  these  indus- 
trial combinations  failed  to  prove  as  successful  as  their  promoters  had  an- 
ticipated. One  set  was  psychological  in  character  and  concerned  with  the 
difficulties  attending  the  administrative  management  of  a  large  business. 
The  other  was  economic  in  character  and  concerned  with  the  difficulties 
attending  the  creation  of  a  business  organization  sufficiently  powerful  to 
dominate  an  industry  in  the  presence  of  actual  or  potential  competition."  * 

It  can  hardly  be  held,  then,  that  great  industrial  combinations 
are,  what  they  have  sometimes  been  called,  "the  natural  products 
of  economic  evolution."  Even  where  one  has  succeeded  in  so 
dominating  a  field  as  to  establish  a  substantial  monopoly,  it  has 
generally  been  found  either  that  it  possessed  one  or  more  of  the 
specific  sources  of  monopoly  power,  or  that  it  was  enabled  by  its 
size  to  avail  itself  of  pecul:arly  destructive  methods  of  com- 
petition. 

Anti-trust  Laws.  — ■  Most  states  have  statutes  and  some  have 
constitutional  provisions  against   "  combinations  in  restraint 

1  A.  S.  Dewing,  Corporate  Promotions  and  Reorganizations,  p.  558.  Dr.  Dewing's 
conclusion,  quoted  above,  is  based  on  a  very  careful  study  of  the  more  important 
reorganizations  of  industrial  combinations.  He  finds  the  following  specific  causes 
of  inefficiency :  (1)  diffusion  of  responsibility;  (2)  lack  of  knowledge  of  individual 
employees ;  (3)  lack  of  loyalty  of  officers  and  directors ;  (4)  lack  of  attention  to  the 
laborious  parts  of  the  business  by  higher  officials ;  (5)  prejudice  of  customers  against 
"  trusts." 


236  OUTLINES  OF  ECONOMICS 

of  trade."  These  are  aimed  primarily  against  large  combina- 
tions of  the  kind  already  described,  although  if  strictly  con- 
strued they  also  make  illegal  the  whole  mass  of  price  agreements 
and  trade  restrictions,  general  and  local,  which  are  a  much  more 
common  and  characteristic  feature  of  modern  business  than  is 
generally  supposed.  State  anti-trust  statutes  have  accomplished 
but  little,  partly  because  they  have  often  been  aimed  at  forms 
rather  than  at  facts,  at  symptoms  rather  than  at  fundamental 
causes,  and  partly  because  they  have  been  used  only  sporadically. 
The  experience  of  the  federal  government  has  shown  that  if  the 
prosecution  of  illegal  combinations  is  to  be  conducted  success- 
fully, there  must  be  thoroughgoing  preliminary  researches  into 
the  history  and  business  methods  of  the  combinations.  The 
state  governments  have  been  poorly  equipped  for  this  kind  of 
work. 

The  Sherman  Anti-trust  Act  of  1890  is  a  federal  statute,  based 
upon  the  federal  power  to  control  interstate  commerce.  It 
declares  illegal  "  every  contract,  combination  in  the  form  of 
trust  or  otherwise,  or  conspiracy,  in  restraint  of  trade  or  com- 
merce among  the  several  states,  or  with  foreign  nations."  It 
also  makes  it  a  misdemeanor  for  any  person  to  "  monopolize, 
or  attempt  to  monopolize,  or  combine  or  conspire  with  any  other 
person  or  persons,  to  monopolize  any  part  of  the  trade  or  com- 
merce among  the  several  states,  or  with  foreign  nations."  The 
most  important  aspect  of  the  statute  is  that  it  gave  the  federal 
courts  jurisdiction  in  these  matters.  The  government  can 
proceed  under  the  statute  in  either  or  both  of  two  ways :  (1)  by 
bringing  criminal  prosecutions  against  persons  entering  into 
unlawful  combinations ;  (2)  by  instituting  proceedings  to  pre- 
vent and  restrain  violations  of  the  law.  A  number  of  criminal 
prosecutions  have  been  made,  but  most  of  these  have  been  un- 
successful. It  has  been  found  difficult  to  get  a  jury  to  convict 
for  an  offense  so  abstract  and  general  and,  possibly,  so  common, 
as  "  restraint  of  trade."  The  more  important  results  of  the 
law  have  come  from  proceedings  for  the  dissolution  of  unlawful 
combinations,  and  it  is  these  only  that  we  shall  discuss. 

There  has  been  much  discussion  of  the  precise  meaning  of  the 


BUSINESS   ORGANIZATION  237 

phrase  "  restraint  of  trade  "  as  used  in  the  Sherman  Act.  This 
phrase  was  taken  from  the  common  law,  in  which  its  usual  appli- 
cation was  to  contracts  by  which  a  man  agreed  not  to  compete 
with  certain  others.  When  the  restraint  of  trade  involved  in 
such  agreements  was  merely  incidental  to  some  legitimate  pur- 
pose, and  necessary  in  order  to  carry  out  that  purpose,  the  con- 
tracts have  usually  been  deemed  valid  at  common  law.  Thus,  if 
two  competitors  form  an  ordinary  partnership,  or  if  one  man  sells 
his  business  to  another,  agreeing  not  to  set  up  another  business 
undertaking  of  the  same  kind  (so  as  to  protect  the  sale  of  the 
good-will  of  his  former  business),  the  restraint  of  competition 
involved  in  such  contracts  does  not  necessarily  render  them  ille- 
gal. But  if  the  direct  purpose  of  a  contract  is  restraint  of  trade 
it  is  invalid  and  unenforceable  and  under  some  circumstances 
criminal. 

Although  the  Sherman  Act  was  intended  to  be  primarily  a 
weapon  against  great  industrial  combinations,  it  has  been  held 
by  the  courts  to  apply  also  to  labor  unions  and  railway  combina- 
tions. It  has  never  been  held,  however,  that  labor  unions  are 
illegal  under  the  act  because  of  any  alleged  restraint  of  competi- 
tion in  the  supply  of  labor.  But  certain  activities  of  labor  unions, 
particularly  strikes  and  boycotts,  have  been  condemned  by  the 
federal  courts  because  such  activities  "  interfere  with  the  free 
flow  of  commerce  from  state  to  state."  *  This,  it  will  be  noted, 
is  a  very  different  thing  from  restraint  of  trade  in  the  old  com- 
mon-law sense. 

In  1897  the  Supreme  Court  held  that  railroad  rate  agreements 
were  in  violation  of  the  Sherman  Act.2  An  important  point  in 
these  decisions  was  that  neither  the  fact  that  railroad  rates 
agreements  had  been  defended  by  the  Interstate  Commerce 
Commission  nor  the  claim  that  the  rates  agreed  upon  were  rea- 
sonable was  allowed  to  stand  as  a  defense.  If  the  direct  purpose 
of  such  agreements,  said  the  court,  is  restraint  of  competition, 

1  United  Slates  v.  Workingmen's  Amalgamated  Council,  55  Fed.  605  ;  the  Railway 
Strike  Cases,  64  Fed.  30,  749,  and  67  Fed.  705;  Loewe  v.  Lawlor  (the  Danbury 
Hatters'  Case),  208  U.  S.  274. 

2  United  States  v.  Trans-Missouri  Freight  Association,  166  U.  S.  2go;  United 
States  v.  Joint  Traffic  Association,  171  U.  S.  505  (1898). 


238  OUTLINES  OF   ECONOMICS 

they  are  illegal,  whether  reasonable  or  not.  Railroad  rate  agree- 
ments still  exist,  but  no  more  of  them  have  been  attacked  by  the 
government.  An  epoch-making  decision  was  that  which  in  1904 
ordered  the  dissolution  of  a  New  Jersey  corporation,  a  holding 
company,  organized  to  hold  the  stock  of  the  Great  Northern 
and  Northern  Pacific  railroads,  two  "  parallel  and  (supposedly) 
competing  "  lines.1  The  importance  of  the  decision  is  that  for 
the  first  time  the  holding  company,  as  an  instrument  for  restrain- 
ing competition,  was  shown  to  be  vulnerable  to  legal  attack. 
But  the  application  of  the  Sherman  Act  to  railway  combina- 
tions is  in  many  ways  unfortunate.  Under  the  Interstate  Com- 
merce Act  we  have  since  1887  regulated  railway  rates  on  the  as- 
sumption that  railways  are  natural  monopolies,  and  this  has 
proved  a  much  more  effective  method  of  dealing  with  unfair 
rates  than  has  the  attempt  to  force  competition  into  the  railway 
field.  The  good  accomplished  by  the  dissolution  of  railway  com- 
binations lies  in  the  inroads  these  dissolutions  have  made  into 
the  use  of  the  holding  company  device,  with  its  undue  concen- 
tration of  financial  power  and  its  opportunities  for  the  unfair 
treatment  of  minority  stockholders.  But  this  is  only  an  inci- 
dental result  of  these  decisions,  and  lies  quite  outside  the  general 
purpose  of  the  Sherman  Act.  Many  large  holding  companies, 
in  both  the  railroad  and  the  manufacturing  fields,  are  wholly 
invulnerable  to  prosecution  as  "  combinations  in  restraint  of 
trade." 

For  twenty  years  the  Sherman  Act  was  least  effective  in  the 
very  field  to  which  it  had  been  particularly  designed  to  apply. 
A  few  industrial  pools  and  price  agreements  were  declared  illegal 
by  the  federal  courts,  but  in  the  only  case  involving  a  trust  of 
the  modern  type  that  came  before  the  Supreme  Court  the  deci- 

1  United  Slates  v.  Northern  Securities  Co.,  193  U.  S.  197.  A  similar  decision, 
in  191 2,  involving  interests  of  even  greater  magnitude,  dissolved  the  merger  of  the 
Union  Pacific  and  Southern  Pacific  railroads  (226  U.  S.  61).  In  the  St.  Louis  Termi- 
nal Railroad  case  (224  U.  S.  283),  also  decided  in  191 2,  a  corporation  owned  by  fif- 
teen railroads,  and  possessing  a  monopoly  of  railroad  terminal  facilities  in  St.  Louis, 
was  not  dissolved,  hut  was  merely  directed  so  to  recoastruct  its  organization  that 
new  companies  might  participate  in  its  ownership  and  be  given  the  advantages  of 
its  services  on  equal  terms  with  railroads  then  in  control  of  it. 


BUSINESS  ORGANIZATION  239 

sion  was  for  the  defendant  corporation.1  For  many  years 
there  were  few  prosecutions  of  industrial  combinations.  The 
government  lacked  properly  equipped  bureaus  of  research  and 
investigation,  and  the  government  officials  were  apparently 
apathetic.  But  both  of  these  conditions  were  changed  during 
President  Roosevelt's  administration.  Finally,  in  1910,  the 
government  was  successful  in  suits  brought  for  the  dissolution 
of  two  of  the  greatest  of  industrial  combinations,  the  Standard 
Oil  Company 2  and  the  American  Tobacco  Company.3  Possi- 
bly the  most  important  thing  in  these  decisions  was  the  emphasis 
the  Supreme  Court  placed  on  certain  business  practices  of  these 
companies  as  evidence  of  their  monopolistic  intent.  Each  com- 
pany had  achieved  a  dominating  position  in  its  field,  and  the 
Standard  Oil  Company,  at  least,  had  a  virtual  monopoly. 
Helped  at  first  by  railroad  rebates,  it  had  consistently  pursued 
a  policy  of  monopolization,  either  absorbing  its  competitors 
or  driving  them  out  of  business.  The  evidence  showed  that 
it  had  acquired  from  85  to  97  per  cent  of  the  business  of  trans- 
porting, manufacturing,  and  selling  petroleum  and  its  products, 
and  such  competition  as  there  was  seems  to  have  existed  by 
its  sufferance.  It  did  not  have  a  natural  monopoly,  for  only 
about  one  ninth  of  the  total  national  production  of  crude  oil 
came  from  its  own  wells.  It  had  certain  advantages  over  its 
competitors,  especially  in  its  control  of  pipe  lines  and  in  the  low 
railroad  rates  given  to  points  at  which  its  refineries  were  located. 
Yet  it  did  not  have  a  full  measure  of  monopoly  power.  Ac- 
tive competition  was  always  possible  and  was  kept  down  only 
by  the  use  of  what  have  come  to  be  called  unfair  competitive 
methods. 

Unfair  competition  has  come  to  play  a  very  important  part 
in  the  trust  problem.  It  includes  the  use  of  such  devices  as 
(1)  cutting  prices  below  cost  in  a  locality  in  which  competition 

1  United  States  v.  E.  C.  Knight  Co.,  156  U.  S.  The  decision  in  this  case,  in- 
volving the  American  Sugar  Refining  Company,  was  to  the  effect  that  a  monopoly 
in  the  manufacture  of  sugar  could  not  be  held  to  be  a  monopoly  in  interstate  com- 
merce. 

2  221  U.  S.  1. 

3  221   U.   S.    l8l. 


240  OUTLINES  OF   ECONOMICS 

appears ;  (2)  discriminating  in  favor  of  merchants  who  agree 
to  refuse  to  handle  or  to  discriminate  against  competitors'  prod- 
ucts; (3)  the  use  of  threats  and  other  forms  of  intimidation, 
(4)  the  employment  of  spies  to  ascertain  the  details  of  competi- 
tors' business  transactions ;  (5)  the  production  of  special  brands 
of  goods,  sold  at  very  low  prices  for  the  purpose  of  driving 
competitors'  products  out  of  the  market;  (6)  the  use  of  sub- 
sidiary companies  as  bogus  independent  concerns.  Most  of 
these  methods  were  not  in  themselves  illegal.  Some  of  them, 
including  price-cutting  on  one  or  more  parts  of  an  establishment's 
output,  are  common  in  ordinary  competitive  trade.  But  when 
used  by  large  industrial  combinations  such  methods  have  come 
to  be  called  "  unfair,"  because  of  the  purposes  prompting  their 
use  and  because  of  their  effects.  There  is  a  very  important 
difference  between  an  effort  to  gain  as  much  business  as  one  can 
under  competitive  conditions  and  an  effort  to  destroy  competi- 
tive conditions.  And  methods  that  may  be  harmless  when 
used  by  an  enterprise  of  ordinary  size  become  dangerously 
destructive  weapons  in  the  hands  of  great  industrial  combina- 
tions. The  combination  is  able  to  wage  a  destructive  competi- 
tive warfare  because  it  can  stand  a  loss  at  one  point  or  on  one 
part  of  its  output  large  enough  to  send  its  smaller  competitor 
into  bankruptcy.  The  use  of  unfair  methods  of  competition 
by  the  Standard  Oil  Company  and  the  American  Tobacco 
Company  was  deemed  by  the  Supreme  Court  weighty  evidence 
of  the  purpose  of  those  combinations  to  monopolize  "trade  and 
commerce  "  in  their  respective  fields. 

These  decisions  showed  that  the  Sherman  Act  could  be  used 
as  an  efficient  tool  for  the  dissolution  of  great  industrial  com- 
binations organized  and  conducted  with  monopolistic  intent. 
Since  1910  a  number  of  successful  suits  have  been  brought  for 
the  dissolution  of  other  trusts,  while  yet  others  have  voluntarily 
reorganized  in  accordance  with  plans  approved  by  the  govern- 
ment.1 It  is  too  early  to  judge  of  the  ultimate  effects  of  these 
dissolutions.  There  can  be  no  doubt,  however,  that  in  a  number 
of  industries,  including  the  oil  and  tobacco  industries,  there  is 

1  See  the  Annual  Reports  of  the  Attorney  General,  for  igio  and  subsequent  years 


BUSINESS  ORGANIZATION  241 

a  larger  measure  of  normal  competition  than  before  the  disso- 
lutions. 

The  reorganization  of  industrial  combinations  in  such  a  way  as  to  comply 
with  the  law  often  presents  difficult  problems.  Where  the  trust  is  a  holding 
company  it  is  impossible  to  distribute  its  stock  holdings  to  the  original 
owners  or  their  heirs,  for  many  of  the  holding  company's  own  securities 
will  have  changed  hands  since  its  organization.  At  first  the  courts  merely 
directed  that  the  securities  owned  by  the  holding  company  be  distributed 
pro  rata  among  its  own  stockholders.  But  where  a  majority  of  the  stock  of 
the  holding  company  was  closely  held  by  a  small  group  of  men,  and  where 
the  holding  company  held  a  substantial  majority  of  the  stock  of  its  more 
important  subsidiary  companies,  this  method  of  dissolution  was  unlikely 
to  result  in  the  prompt  restoration  of  normal  competitive  conditions  in  the 
industry.  More  recently  the  dissolution  plans  have  been  more  carefully 
worked  out,  so  that  no  one  group  of  stockholders  is  left  in  control  of  all 
the  different  constituent  parts  of  the  former  combination. 

In  19 14  Congress  enacted  two  new  statutes,  the  Clayton 
Anti-trust  Act  and  the  Federal  Trade  Commission  Act.  The 
Clayton  Act  is  designed  to  accomplish  a  number  of  different 
things.     We  can  mention  only  its  more  important  provisions: 

1.  It  definitely  legalizes  those  activities  of  labor  unions 
which  had  been  declared  illegal  under  the  Sherman  Act.  This 
topic  is  discussed  elsewhere  in  this  volume.1*"" 

2.  It  prohibits  the  acquisition  by  one  corporation  of  stock 
in  another  corporation  when  the  effect  may  be  "to  substan- 
tially lessen  competition  "  between  such  corporations,  or  "to 
tend  to  create  a  monopoly."  It  also  makes  it  illegal  for  a  man 
to  serve  (1)  as  a  director  or  officer  of  a  bank  in  the  Federal 
Reserve  system  and  at  the  same  time  as  a  director  or  officer 
of  any  other  bank  or  as  a  private  banker,  when  one  bank  has 
liabilities  of  more  than  $5,000,000  or  when  both  are  located 
in  a  large  city ;  (2)  as  an  officer  or  director  of  a  common  carrier 
and  at  the  same  time  as  an  officer  or  director  of  a  firm  having 
large  dealings  with  the  carrier  in  securities,  supplies,  or  contracts 
for  construction  or  maintenance  (unless  under  publicly  super- 
vised competitive  bidding) ;  (3)  as  a  director  of  two  or  more 
industrial  corporations  engaged  in  interstate  commerce,  if  one 

1  Chap.  XXIII. 


242  OUTLINES   OF   ECONOMICS 

has  an  aggregate  "capital,  surplus,  and  undivided  profits  "of 
more  than  $1,000,000  and  if  they  are,  "by  virtue  of  their  busi- 
ness and  location  of  operation,  competitors."  These  provi- 
sions against  "  interlocking  "  directors  and  officers,  like  the 
provision  against  intercorporate  stockholding,  have  a  whole- 
some purpose  and  may  accomplish  some  good  in  particular 
cases.  But  so  far  as  their  effect  upon  industrial  combinations 
is  concerned  they  add  little  to  the  Sherman  Act,  as  now  inter- 
preted by  the  courts.  It  will  be  noted,  however,  that  intercor- 
porate stockholdings  and  intercorporate  directorates  are  pro- 
hibited by  the  Clayton  Act  when  they  may  tend  to  lessen 
competition  between  the  corporations  directly  concerned, 
even  though  general  competitive  conditions  may  continue  in 
the  industry  in  which  the  corporations  are  engaged. 

3.  The  Clayton  Act  prohibits  certain  trade  practices,  in- 
cluding (1)  unjustifiable  discrimination  in  the  prices  charged 
to  different  purchasers,  (2)  leases  or  sales  of  goods  made  with 
the  understanding  that  the  lessee  or  purchaser  shall  not  use 
or  deal  in  the  goods  of  a  competitor  of  the  lessor  or  seller,  as 
well  as  special  discounts  or  rebates  made  upon  such  conditions. 
In  cases  under  the  Sherman  Act  the  courts,  as  we  have  seen, 
had  already  counted  the  use  of  such  practices  among  the  evi- 
dences of  an  illegal  purpose  to  monopolize  an  industry.  And 
injunctions  against  their  further  use  have  been  included  in  the 
decrees  in  some  of  these  cases.  If  follows  that  in  these  particu- 
lars, also,  the  Clayton  Act  adds  little  to  the  Sherman  Act. 

The  Federal  Trade  Commission,  established  in  1914,  is  com- 
posed of  five  members,  appointed  by  the  President.  It  suc- 
ceeds the  Bureau  of  Corporations,  which  was  established  in 
1903  for  the  primary  purpose  of  making  special  investigations 
of  particular  corporations  and  combinations  and  of  the  condi- 
tions existing  in  particular  industries.  The  Federal  Trade 
Commission  not  only  has  large  powers  of  investigation,  but  it 
has  the  further  power  to  require  annual  or  special  reports  from 
interstate  corporations  in  such  form  and  relating  to  such  matters 
as  it  may  prescribe.  At  the  request  of  the  Attorney  General 
it  is  to  investigate  any  corporation  alleged  to  be  violating  the 


BUSINESS  ORGANIZATION  243 

anti-trust  laws,  and  to  make  recommendations  for  the  read- 
justment of  its  business.  In  suits  brought  under  the  anti- 
trust acts  the  Commission  may  be  asked  by  the  court  to  pre- 
pare an  appropriate  form  of  decree,  which  is,  of  course,  subject 
to  rejection  or  change  by  the  court.  The  importance  of  this 
provision  is  in  its  bearing  upon  the  outcome  of  dissolution  pro- 
ceedings under  the  Sherman  Act.  The  drafting  of  a  wise  plan 
of  reorganization  for  an  offending  combination  is  often  an  ex- 
ceedingly difficult  matter,  requiring  not  only  care  and  judg- 
ment, but  also  a  large  amount  of  technical  information  about 
the  general  condition  of  the  industry  affected.  Furthermore, 
the  Commission  is  authorized  to  make  investigations  of  the 
manner  in  which  decrees  in  suits  under  the  anti-trust  act?  «re 
carried  out. 

The  most  important  power  of  the  Federal  Trade  Commission 
is  undoubtedly  that  of  issuing  orders  restraining  the  use  of 
"  unfair  methods  of  competition  in  commerce."  So  far  as 
such  methods  are  used  as  part  of  a  general  attempt  to  monop- 
olize an  industry,  the  new  statute  adds  nothing  to  the  Sherman 
Act  except  a  new,  prompt,  and  efficient  method  of  procedure. 
If  this  power  is  wisely  used  it  should  be  possible  in  many  cases 
to  put  a  stop  to  aggressive  monopolizing  in  its  early  stages, 
before  much  harm  has  been  done.  But  the  power  committed 
to  the  Federal  Trade  Commission  has  even  wider  aspects.  It 
is  to  be  hoped  that  the  Commission  may  be  able  to  build 
up  and  maintain  higher  standards  for  competitive  business 
methods  in  general ;  that  it  may  fix  the  lines  beyond  which 
one  should  not  go  in  the  attempt  to  divert  trade  from  one's 
competitors. 

Public  Policy  towards  Industrial  Combinations.  —  Our 
anti-trust  laws  express  what  is  undoubtedly  the  dominant 
public  sentiment  in  the  United  States  with  respect  to  large 
industrial  combinations  formed  with  the  purpose  of  obtaining 
a  monopoly.  Our  policy  has  been  one  of  repression,  of  compul- 
sory disintegration.  Undoubtedly  we  have  made  many  blun- 
ders in  the  ways  in  which  we  have  formulated  and  enforced  this 
policy.     We  have,  in  some  cases,  attempted  to  force  competition 


244  OUTLINES  OF  ECONOMICS 

into  the  field  of  the  natural  monopolies ;  we  have  often  attrib- 
uted too  large  a  significance  to  the  mere  fact  of  combination  ; 
we  have  in  particular  attempted  to  cure  by  a  sweeping  prohi- 
bition of  "  restraint  of  trade  "  and  "  monopolizing  "  many 
evils  that  are,  in  their  more  important  aspects,  matters  of  cor- 
poration finance,  rooted  in  the  laxity  of  our  statutes  in  respect 
to  the  organization  and  management  of  corporations.  But 
this  does  not  mean  that  our  general  policy  has  been  fundamen- 
tally mistaken.  Monopoly  has  yet  to  prove  itself  more  efficient 
than  competition.  And,  moreover,  it  is  not  entirely  a  ques- 
tion of  economic  efficiency.  There  are  differences  between 
monopoly  and  competition  in  their  effects  upon  the  distribu- 
tion of  wealth,  upon  the  equality  of  economic  opportunity,  and 
upon  a  host  of  economic  and  social  relations ;  and  in  most  of 
these  particulars,  it  is  generally  believed,  the  advantage  rests 
with  competition.  At  any  rate,  we  are  proceeding  along  sound 
lines  in  endeavoring  to  raise  the  level  of  competitive  methods 
and  to  eliminate  any  advantages  which  large  combinations  may 
have  in  their  power  of  destructive  competition.  This  will  give 
a  fairer  field  for  experimentation  with  respect  to  the  forms  of 
business  organization  really  best  fitted  for  survival. 

There  are  some  who  believe  that  our  general  policy  has  been 
wholly  mistaken ;  that  we  should  permit  and  even  encourage  the 
formation  of  large  combinations ;  that  we  should  place  monopoly 
power  in  their  hands,  and  that  we  should  then  subject  their 
prices  and  their  products  to  public  control  of  the  kind  that  now 
exists  in  the  railway  field.  Now  there  is,  in  fact,  no  good  reason 
why  our  notions  of  what  constitutes  a  "  public  calling,"  or  a 
"  business  affected  with  a  public  interest,"  properly  subject 
to  rigid  public  control,  should  not  be  extended  so  as  cover  all 
natural  monopolies.  But  to  regulate  prices  in  any  industrial 
field,  not  naturally  monopolistic,  would  be  an  exceedingly  diffi- 
cult and  complex  undertaking.  It  would  also  be  difficult  to 
define  the  terms  on  which  new  capital  and  new  enterprise  might 
come  into  the  "  regulated  "  industry.  And  there  is,  as  yet, 
no  proof  that  this  proposed  change  in  policy  would,  if  put  into 
effect,  result  in  any  large  economic  or  social  gains 


BUSINESS  ORGANIZATION  245 

Federal  Control  of  Corporations.  —  The  unfortunate  effects 
of  the  lack  of  uniform  state  requirements  in  such  matters  as 
purposes  of  incorporation,  corporate  powers,  qualifications 
and  responsibilities  of  promoters  and  directors,  capitalization, 
and  the  like  could  in  large  measure  be  remedied  by  federal 
action.  The  Clayton  Act  touches  only  incidentally  upon  this 
field.  Its  provisions  relating  to  incorporate  stockholdings 
and  interlocking  directorates  were  framed  with  reference 
merely  to  the  problem  of  the  preservation  of  competitive  con- 
ditions. What  is  needed  is  a  federal  statute  dealing  thoroughly 
and  systematically  with  the  promotion,  organization,  and 
management  of  corporations  engaged  in  interstate  commerce. 
Canal,  railway,  and  bridge  companies  have  in  the  past  been 
chartered  by  the  federal  government,  just  as  national  banks  are 
now.  It  would  be  legally  possible  and  economically  advisable 
to  require  at  least  a.  federal  license  from  all  corporations  engaging 
in  interstate  commerce.  Moderate  and  just  requirements  as 
to  publicity,  capitalization,  and  other  things  might  very  well 
be  imposed  as  the  price  of  federal  license.  Aside  from  the 
present  lack  of  uniformity  in  state  laws,  the  mere  size  of  modern 
business  corporations  and  the  interstate  scope  of  their  opera- 
tions make  it  difficult  for  any  individual  state  or  states  to 
control  them  efficiently. 

Industrial  Combinations  in  Other  Countries.  —  A  move- 
ment toward  combination  in  some  form  has  manifested  itself 
in  practically  every  country  which  has  large  industries  of  the 
modern  type.  In  England,  however,  the  movement  has  made 
much  less  headway  than  in  the  United  States.  This  may  be 
attributed  in  part  to  the  fact  that  England's  "  company  laws  " 
are  not  so  lax  as  are  the  corporation  laws  of  many  of  our  states, 
in  part,  possibly,  to  the  absence  of  a  protective  tariff,  and  in 
part  to  the  highly  specialized  character  of  English  industries. 
During  the  past  twenty  or  thirty  years,  however,  a  number  of 
important  combinations  have  been  formed  in  England,  but 
only  a  few  of  these  have  been  successful.  An  English  combina- 
tion, .it  may  be  noted,  has  an  international  monopoly  of  sewing 
cotton.     England    has    no    statute    forbidding    combinations, 


246  OUTLINES   OF   ECONOMICS 

but  the  contracts  by  which  "  combinations  in  restraint  of  trade  " 
are  formed  will  not  be  enforced  by  the  courts. 

In  Germany  and  in  certain  other  countries  of  continental 
Europe  the  dominant  form  of  combination  is  the  Kartell. 
This  resembles  a  pool  more  than  it  does  the  thoroughly  central- 
ized industrial  combinations  of  the  United  States.  The  Kartell 
itself  is,  however,  usually  organized  as  a  joint-stock  company. 
The  individual  companies  constituting  its  membership  continue 
as  independent  producing  establishments.  The  Kartell  con- 
trols sales,  prices,  output,  and  the  distribution  of  orders  and  of 
profits.  Opinions  in  Germany  with  respect  to  the  success  of 
the  Kartells  is  greatly  divided.  On  the  one  hand  it  is  claimed 
that  they  have  eliminated  many  of  the  wastes  of  competition  and 
that  they  have  been  especially  active  and  successful  in  securing 
sales  in  foreign  markets.  On  the  other  hand  it  is  charged  that 
they  have  discriminated  against  home  consumers  by  selling 
abroad  at  lower  prices  than  they  charge  at  home,  and  that  they 
even  go  so  far  as  to  sell  at  very  different  prices  in  different  part 
of  Germany,  utilizing,  as  far  as  possible,  the  principle  of  "  charg- 
ing what  the  traffic  will  bear."  In  1906,  when  a  government 
investigation  was  made,  there  were  384  Kartells  in  Germany,  and 
many  new  ones  have  been  organized  in  subsequent  years.  Note- 
worthy among  the  German  Kartells  have  been  the  Rhenish- 
Westphalian  Coal  Syndicate  (of  which  the  Prussian  govern- 
ment, as  a  large  mine  owner,  was  for  a  short  time  a  member) 
and  the  Steel-works  Association. 

QUESTIONS  AND  EXERCISES 

1.  What  are  the  terms  under  which  corporations  are  chartered  in  your 
own  state?    What  anti- trust  laws  are  in  force  there? 

2.  Explain  the  various  items  in  the  published  balance  sheet  of  some  in- 
dustrial corporation. 

3.  What  limitations  should  be  attached  to  the  statement  that  "a  cor- 
poration is  a  fictitious  person"? 

4.  Does  the  word  "capital"  mean  the  same  thing  in  accounting  and  in 
economics  ? 

5.  Report  on  the  history  of  one  of  the  following :  United  States  Steel 
Corporation;     American  Sugar  Refining  Company;     American  Tobacco 


BUSINESS   ORGANIZATION  247 

Company;     International  Harvester    Company;     United  States  Leather 
Company ;   Rhenish-Westphalian  Coal  Syndicate". 

6.  What  advantages  has  a  large  plant?     a  large  business  unit?     a 
monopoly  ? 

7.  What   special  burdens  are  imposed   upon   corporations?     Has   the 
corporation  any  other  disadvantages  as  a  form  of  business  organization? 

8.  In  what  respects  do  the  Clayton  Anti-trust  Act  and  the  Federal  Trade 
Commission  Act  cover  the  same  ground? 

REFERENCES 

Bureau  of  Corporations.     Special  Reports  on  various  industries. 

Carter,  G.  R.     The  Tendency  towards  Industrial  Combinations. 

Clark,  J.  B.  and  J.  M.     The  Control  of  Trusts. 

Dewing,  A.  S.     Corporate  Promotions  and  Reorganizations. 

Durand,  E.  D.     The  Trust  Problem. 

Federal  Trade  Commission.     Annual  and  Special  Reports. 

Gerstenberg,  C.  W.  (editor).    Materials  of  Corporation  Finance. 

Haney,  L.  H.     Business  Organization  and  Combination. 

Jenks,  J.  W.     The  Trust  Problem. 

Lough,  W.  H.     Corporation  Finance. 

Lyon,  W.  H.     Capitalization,  a  Handbook  of  Corporation  Finance. 

Meade,  E.  S.     Trust  Finance;   Corporation  Finance. 

Orth,  S.  P.  (compiler).  Readings  on  the  Relation  of  Government  to  Prop- 
erty and  Industry,  Parts  iv,  viii,  ix. 

Railroad  Securities  Commission.     Report. 

Ripley,  W.  Z.  Railroads :  Finance  and  Organization;  (editor)  Trusts, 
Pools,  and  Corporations. 

Stevens,  W.  S.  (editor).     Industrial  Combinations  and  Trusts. 

Van  Hise,  C.  R.     Concentration  and  Control. 

Wyman,  Bruce.     The  Control  of  the  Market. 

Young,  A.  A.  "The  Sherman  Act  and  the  New  Anti-trust  Legislation," 
Journal  of  Political  Economy,  vol.  xxiii,  pp. 2 10-2 20,  305-326,  417-436. 


CHAPTER  XIV 
MONEY 

The  vast  system  of  exchange,  which  is  the  most  characteristic 
single  feature  of  present-day  economy,  rests  upon  the  use  of 
money.  We  have  seen  that  some  economic  writers  have  pic- 
tured an  imaginary  primitive  state  of  "  barter  economy  "  ;  in 
which,  before  the  use  of  money,  goods  were  exchanged  directly 
for  goods.  But  what  little  definite  information  there  is  on  this 
point  leads  us  to  the  belief  that  about  as  soon  as  men  began  to 
exchange  things,  and  consequently  to  attribute  exchange  value 
to  them,  they  began  to  use  some  kind  of  money  —  some  commod- 
ity or  commodities  for  which  things  were  generally  exchanged, 
and  in  terms  of  which  the  values  of  other  things  were  generally 
stated. 

The  earliest  forms  of  money  were  crude  and  simple,  but  they 
sufficed  to  meet  simple  needs.  As  exchange  economy  has  ad- 
vanced to  the  present  complex  division  of  labor,  the  monetary 
system  has  developed  pari  passu,  the  most  conspicuous  feature 
of  this  development  in  modern  times  being  the  growing  impor- 
tance of  credit  as  a  means  of  effecting  exchanges.  Industrial  and 
commercial  progress  has  led  to  monetary  progress,  and  has,  in 
turn,  been  stimulated  and  made  possible  by  it. 

Metallic  Money.  —  The  earliest  and  simplest  forms  of  money 
were  commodities.  Particular  commodities  came  to  serve  as 
money,  not  because  they  were  arbitrarily  designated  as  such 
by  king  or  chieftain,  but  because  they  possessed  some  properties 
which  made  them  exceptionally  exchangeable.  In  some  cases 
a  primitive  community  came  to  use  a  commodity  as  money  be- 
cause it  was  something  for  which  they  had  a  dependable  "  for- 
eign market  "  — something,  that  is,  which  they  customarily  soki 
to  other  communities  in  exchange  for  their  products.     In  other 

2J8 


MONEY  249 

cases  a  commodity  which  a  community  did  not  itself  produce, 
but  which  it  got  only  in  the  course  of  trade  with  other  com- 
munities, became  the  money  commodity-  Or,  if  for  any  reason 
a  particular  commodity  came  to  be  particularly  esteemed  as  a 
mark  of  wealth  or  a  badge  of  social  prestige,  it  was  likely  to  used 
as  money.  But  whatever  the  original  ground  of  the  choice,  a 
commodity  which  a  community  once  began  to  think  of  as  money 
had  its  exchangeability,  and  consequently  its  suitability  for 
monetary  uses,  increased  in  a  cumulative  way,  just  as  today 
most  of  us  are  willing  to  accept  anything  as  money  which  we 
think  we  can  use  as  money. 

A  great  variety  of  commodities  have  at  one  time  or  another 
been  used  as  money.  Some  typical  examples  are  cattle,  grain, 
furs,  oil,  salt,  tobacco,  ivory,  shells,  and  tea.  But  with  the  ad- 
vance of  political  and  economic  civilization  the  metals  have, 
through  the  process  of  the  survival  of  the  fittest,  proven  them- 
selves everywhere  to  be  preeminently  and  indisputably  the  best 
money  commodities.  Copper,  silver,  and  gold  have  each  in  turn 
been  chosen  as  the  principal  money  metal  of  the  civilized  world, 
the  transition  from  the  cheaper  to  the  dearer  metals  indicating 
the  growth  of  exchange  and  of  wealth  and  the  consequent  need 
of  larger  money  units. 

Metals,  and  especially  the  precious  metals,  have  certain  quali- 
ties that  give  them  a  peculiar  fitness  to  serve  as  money.  They 
are  durable,  easily  recognized  and  tested,  and  may  be  divided 
into  homogeneous  units  of  convenient  form  and  weight.  More- 
over, as  compared  with  most  other  commodities,  the  precious 
metals  are  relatively  stable  in  value.  This  arises  in  part  from 
their  durability,  for  any  one  year's  output  of  the  mines  makes  but 
a  comparatively  small  addition  to  the  total  stock  of  metallic 
money,  and  in  part  from  the  nature  of  their  non-monetary  uses, 
for  the  demand  for  commodities  that  minister  to  our  tastes  for 
ornament  and  display  is  much  more  elastic  than  the  demand  for 
necessaries  of  life. 

Coinage.  —  When  metals  were  first  used  as  money,  they  passed 
from  hand  to  hand  simply  by  weight,  or,  in  some  cases,  in  the 
form  of  ornaments.     Coinage  speedily  developed,  however,  as 


250  OUTLINES  OF  ECONOMICS 

a  convenient  way  of  certifying  to  the  weight  and  fineness  of 
money  units.1 

Such  a  guarantee  is  naturally  of  little  avail  unless  it  is  generally 
recognized  as  authoritative.  On  this  account  the  coinage  of 
money  has  almost  universally  been  regarded  as  a  prerogative  of 
the  sovereign.  In  England,  even  under  the  divided  sovereignty 
of  the  Middle  Ages,  the  coining  of  gold  and  silver  was  generally 
a  privilege  belonging  to  the  king  alone.  The  lesser  feudal  lord 
and  the  chartered  cities  issued  token  coins,  made  of  the  baser 
metals,  and  intended  especially  for  local  use,  but  if  they  possessed 
the  right  of  coining  the  precious  metals,  it  was  through  a  special 
grant  of  the  king. 

The  Meaning  of  "  Money."  —  In  modern  economic  life 
many  things  in  addition  to  coined  metals  are  included,  and 
properly  included,  under  the  name  of  money.  There  is,  how- 
ever, no  definite  line  of  demarcation  between  the  things  which 
are  money  and  the  things  which  are  not  money,  consistently 
followed  in  common  usage,  or  even  in  economic  writings.  But 
we  may  agree,  to  begin  with,  that  money  is  what  we  exchange 
for  things  when  purchasing  them,  and  that  sellers  are  willing  to 
accept  it,  at  stated  prices,  in  exchange  for  their  goods.  Then, 
however,  we  have  to  take  account  of  the  fact  that  many  ex- 
changes are  credit  transactions ;  that  is,  that  the  immediate 
equivalent  given  in  exchange  for  a  thing  is  a  promise  to  pay  a 
certain  amount  of  money.  This  suggests  that  we  should  dis- 
tinguish between  "  money  "  and  "  credit  instruments."  But 
when  we  push  our  analysis  a  little  further  we  find  that  the  ele- 
ment of  credit  is  found  in  many  of  the  things  that  we  ordinarily 
call  money,  even,  as  we  shall  see,  in  some  kinds  of  metallic 
money. 

A  useful  and  important  distinction,  however,  is  implied  in  the 
very  common  practice  of  restricting  the  use  of  the  name 
"  money  "  to  those  instruments  of  general  acceptability  which 

1  The  names  of  many  ancient  coins  and  of  some  modern  ones  are  also  the  names 
of  weights,  although  it  has  generally  happened  that  through  successive  debasements 
of  the  coinage  these  names  have  lost  their  original  significance.  The  Greek  talent, 
the  Jewish  shekel,  the  Roman  as,  the  Chinese  tael,  the  English  pound,  and  the 
French  livre  are  familiar  examples. 


MONEY  251 

pass  freely  from  hand  to  hand  as  media  of  exchange.  The  particu- 
lar things  thus  to  be  counted  as  money  vary  for  different  periods 
and  for  different  countries.  In  the  United  States  this  generally 
acceptable  medium  of  exchange  includes  the  metallic  money 
coined  by  the  federal  government,  the  paper  money  issued  by  it, 
and  bank  notes.  .  Checks  drawn  by  individuals  upon  their  bank 
accounts  are  not  money,  or  money  instruments,  in  this  sense, 
because  they  do  not  pass  freely  from  hand  to  hand  as  media 
of  exchange.  They  can  be  used  only  in  making  payments  to 
persons  who  have  confidence  in  the  honesty  and  solvency  of  the 
one  who  tenders  the  check  for  payment.  Some  things  that 
are  part  of  the  generally  acceptable  media  of  exchange  are  them- 
selves promises  (on  the  part  of  the  government  or  of  banks) 
to  pay  certain  other  forms  of  money  on  demand.  But  the 
important  point  is  that  the  acceptability  of  such  things  does  not 
depend  upon  the  honesty  or  solvency  of  the  person  who  tenders 
them  in  payment.  So  long  as  we  have  confidence  in  the  solvency 
of  the  government  and  the  banks,  their  coins  and  notes,  issued 
in  convenient  and  easily  recognizable  forms  and  denominations, 
are  generally  acceptable  media  of  exchange,  and,  as  such,  are 
money.  This  meaning  of  the  word  has  the  sanction  of  a  very 
common  and  prevalent  usage ;  it  corresponds,  moreover,  to  the 
technical  definition  given  to  the  word  by  many  economic  writers, 
and  to  the  official  usage  of  the  United  States  Treasury.  In  this 
chapter  the  word  "  money  "  will  be  employed  in  this  restricted 
sense  of  money  instruments  of  general  acceptability. 

But  the  word  is  also  often  used  in  a  much  broader  sense.  We 
speak  of  "  money  funds,"  the  "  money  market,"  "  money  ex- 
penditures," "  investments  of  money,"  etc.  And  yet  the 
"  money  market  "  is  not  primarily  a  place  in  which  the  generally 
acceptable  media  of  exchange  are  bought  and  sold,  nor  is  the 
fact  that  one's  "  money  expenditures  "  amount  to  a  given  sum 
to  be  interpreted  as  meaning  that  one  has  actually  paid  out  this 
amount  in  the  generally  acceptable  media  of  exchange.  Money, 
in  this  broad  sense,  includes  credit  in  the  form  of  rights  to  receive 
money  (in  the  narrower  sense  just  defined)  on  demand.  It  is 
these  rights  that  are  bought  and  sold  in  the  money  market  and 


252  OUTLINES  OF  ECONOMICS 

it  is  by  transfers  of  these  rights  that  a  very  large  proportion  of 
the  aggregate  annual  payments  for  goods  and  services  are  made. 
A  payment  made  by  a  bank  check  is,  for  example,  a  transfer 
of  a  right  of  this  kind. 

The  Media  of  Exchange.  —  Some  writers  have  made  a  distinc- 
tion between  the  function  which  money  performs  as  a  medium  of 
exchange,  and  its  function  as  a  measure  of  value.  These  are  not, 
however,  two  different  functions,  but  merely  two  different 
aspects  of  the  same  thing.  By  the  very  process  of  exchanging 
a  commodity  for  money,  we  of  necessity  "  measure  "  its  value 
in  terms  of  money,  and  only  as  a  medium  of  exchange  does  money 
measure  value.  We  may  speak  of  a  pound  weight  as  an  instru- 
ment used  in  weighing  or  as  a  measure  of  weight,  but  we  would 
all  recognize  that  these  are  merely  two  aspects  of  one  function. 

In  the  United  States  the  actual  media  of  exchange  in  terms  of 
which  we  "  measure  values  "  (or  more  accurately,  state  prices) 
comprise  a  variety  of  coins,  made  from  different  metals,  together 
with  several  kinds  of  paper  money  of  many  different  denomina- 
tions.    But  all  these  different  forms  of  money  are  alike  in  name, 

—  that  is,  they  are  dollars,  or  multiples  or  fractions  of  a  dollar, 

—  and  moreover,  these  various  kinds  of  dollars  are  not  distin- 
guished, one  from  another,  in  the  price  lists.  This  familiar  and 
very  satisfactory  condition  of  uniformity  in  the  units  in  which 
we  state  prices  does  not,  however,  suggest  to  us  the  real  nature 
of  money  in  the  way  that  a  less  perfect  monetary  system  would. 

It  would  be  possible  to  have  a  number  of  different  monetary 
units,  just  as  the  weight  or  size  of  an  object  may  be  stated  in 
terms  of  either  the  metric  system  or  the  English  system  of 
weights  and  measures.  In  fact,  before  the  United  States  had  an 
adequate  monetary  system  of  its  own,  the  actual  media  of  ex- 
change consisted  largely  of  English,  French,  Spanish,  and  Portu- 
guese coins,  and  there  were  as  many  different  ways  of  stating 
prices  as  there  were  varieties  of  money.1    Nor  does  the  mere 

1  An  instructive  bit  of  monetary  experience  may  be  found  in  the  efforts  of  some 
of  the  colonies  to  reduce  this  foreign  money,  especially  Spanish  money,  to  the 
English  system  of  pounds,  shillings,  and  pence,  in  which  accounts  were  generally 
kept.  They  were  not  content  with  a  simple  official  statement  of  the  actual  ratios 
between  the  different  value  units,  but  sought  to  give  an  artificially  enhanced  value 


MONEY  253 

name  of  "  dollar  "  give  to  different  pieces  of  money  a  uniform 
purchasing  power.  The  silver  dollar  of  Mexico  will  buy  only 
about  half  as  much  as  the  silver  dollar  of  the  United  States,  al- 
though it  is  of  approximately  the  same  size.  More  significant, 
however,  is  the  fact  that  in  the  United  States  we  have  had  at 
different  times  "  dollars  "  of  unequal  purchasing  power. 

What  is  it,  then,  that  gives  uniformity  to  the  dollar  as  a  price- 
recording  unit  in  our  present  monetary  system?  To  say  that 
various  kinds  of  money  are  equal  in  value  because  they  will  pur- 
chase the  same  amounts  of  goods  is,  obviously,  to  argue  in  a  circle. 
But  the  answer  is  found  in  the  fact  that  they  are  interchangeable, 
and  so  long  as  any  number  of  kinds  of  money,  all  named  in  dollar 
units,  are  freely  exchangeable,  dollar  for  dollar,  it  is  impossible  that 
domestic  prices  stated  in  terms  of  one  kind  of  money  should  be 
higher  or  lower  than  domestic  prices  stated  in  terms  of  any  other 
kind  of  money.  We  do  not  refer  here  to  the  fact  that  different 
Kinds  of  money  are  exchanged  for  each  other  at  par  in  business 
transactions  and  in  banking,  for  this  is  a  result,  rather  than  a 
cause,  of  their  parity.  The  exchangeability  that  underlies  the 
parity  of  our  different  kinds  of  money  is  maintained  by  the 
federal  government. 

All  coins  smaller  than  a  dollar  are  by  law  exchangeable  at  the 
United  States  Treasury  for  "  lawful  money,"  which  includes  gov- 
ernment notes,  silver  dollars,  and  gold  coins.  Government 
notes,  in  turn,  are  simply  promises  to  pay,  which  are  redeemable 
in  gold  at  the  government  treasury.  While  there  is  no  definite 
legal  mandate  requiring  the  redemption  of  silver  dollars  in  gold, 
yet  the  currency  act  of  1900  makes  it  the  duty  of  the  Secretary 
of  the  Treasury  to  maintain  all  other  forms  of  money  at  a  parity 
with  gold  —  a  requirement  which  means  that  he  would  have  to 
redeem  silver  dollars  in  gold  if  such  action  should  at  any  time  be 

to  the  foreign  coins  by  increasing  the  number  of  shillings  to  which  they  were  to  be 
considered  equivalent.  The  result  was  not,  however,  an  increase  in  the  value 
of  the  coins,  but  a  decrease  in  the  value  of  the  nominal  "shilling"  in  which  accounts 
were  kept.  This  was  the  origin  of  the  now  rapidly  vanishing  use  of  the  word  "shil- 
ling" as  equivalent  to  12^  cents  in  some  localities  and  to  i6f  cents  in  others.  The 
student  may  find  an  instructive  parallel  in  this  experience  and  the  official  statement 
of  coin  values  by  which  sovereigns  tried  to  retain  their  seigniorage  profits. 


254  OUTLINES  OF  ECONOMICS 

Money  in  the  United  States:  June,  30,  191 5 l 


In  Treasury, 

Mints,  and 

Federal 

Reserve  Banks 

In  Other  Banks 

and  in 
Circulation 

Total 

Gold  coin  and  bullion   . 
Silver  dollars   .... 
Subsidiary  silver  .     .     . 

$  1,395,405,553 

503,624,499 

26,164,295 

$590,i33,6i9 
64,647,156 

159,265.955 

$1,985,539,172 
568,271,655 
185,430,250 

Total  metallic  .     .     . 

$1,925,194,347 

$814,046,730 

$2,739,241,077 

United  States  notes  .     . 
Federal  reserve  notes     . 
National  bank  notes 

$14,338,770 

3,885,850 

33,880,546 

$332,342,246 

80,374,650 

785,393047 

$346,681,016 

84,260,500 

819,273,593 

Total  notes  .... 

$52,105,166 

$1,198,109,943 

$1,250,215,109 

Aggregate  metallic 
and  notes      .     .     . 

$1,977,209,513 

$2,012,156,673 

$3,989,456,186 

Gold  certificates   .     .     . 
Silver  certificates .    .     . 
Treasury  notes  of  1890 

Total  certificates  and 

$  100,861,170 

11,488,605 

9-3I3 

$  1,072,847,819 

481,970,395 

2,244,687 

— 

Aggregate2  .... 

$112,359,088 

$1,557,062,901 

— 

— 

$3,569,219,574 

$3,989,456,186 

needed  to  maintain  their  parity.  Gold  certificates  and  silver  cer- 
tificates are  simply  a  mechanism  for  putting  gold  and  silver  money 
into  circulation  in  convenient  form.  They  are  analogous  to  ware- 
house receipts,  because  they  represent  gold  coins  and  silver  dollars 
that  are  stored  in  the  government  treasury  to  the  full  amount  of 
the  certificates  issued,  and  which  may  be  obtained  at  any  time  in 
exchange  for  the  certificates.  Bank  notes  (including  federal 
reserve  notes  and  national  bank  notes)  are  redeemed  by  the  fed- 
eral treasury,  which  for  this  purpose  acts  as  an  agent  of  the 
banks  which  have  issued  the  notes.  In  practice  the  government 
is  continually  receiving  all  kinds  of  money,  including  silver  dol- 

1  Finance  Report,  1915,  p.  314. 

*  This  aggregate  does  not  include  "minor  coins,"  principally  bronze  one-cent 
pieces  and  nickel  five-cent  pieces,  of  which  there  were  about  $60,000,000  outstand- 
ing on  June  30,  1915. 


MONEY  255 

lars,  and  exchanging  other  kinds  of  mone>  for  them.  The  sig- 
nificant thing  is  that  all  other  kinds  of  money  are  exchangeable, 
directly  or  indirectly,  for  gold  cain. 

The  Monetary  Standard.  —  In  the  case  of  gold  coin,  there  is 
a  further  kind  of  exchangeability  —  the  unlimited  and  free  con- 
vertibility of  gold  coin  and  gold  btdlion.  So  lo*ng  as  any  one  can 
secure  gold  coin  from  the  mints  in  any  amount  for  the  same  weight 
of  gold  bullion  of  standard  fineness,  and  so  long  as  gold  coin  can 
be  freely  melted  down  into  gold  bullion,  it  is  impossible  that  there 
should  be  any  appreciable  difference  between  the  value  of  a  gold 
coin  and  the  value  of  its  metallic  content.  We  have,  then,  not 
only  the  interchangeability  of  all  parts  of  the  circulating  medium, 
but  also  the  positive  physical  identity  of  one  part  of  it  and  the 
material  of  which  this  part  is  made. 

Gold  coins,  because  their  value  as  bullion  is  equal  to  their  value 
as  coins,  constitute  standard  money.  The  gold  dollar  weighing 
25.8  grains,  and  containing  23.22  grains  of  fine  gold  is  by  law  the 
monetary  unit,  that  is,  the  dollars  in  terms  of  which  prices  are 
stated  are  gold  dollars  or  are  maintained  at  a  parity  with  gold 
dollars.  The  coinage  of  the  gold  dollar  was  discontinued  in 
1890,  but  the  gold  coins  that  are  minted  contain  precisely  this 
amount  of  gold  per  dollar.  Gold,  whether  in  coin  or  bullion, 
constitutes  the  monetary  standard,  for  the  value  of  any  dollar  must 
be  equal  to  the  value  of  the  gold  in  a  gold  dollar.  The  recording 
of  prices  in  terms  of  dollars  through  the  exchange  of  goods  and 
services  for  money  of  different  sorts,  the  maintenance  of  the 
parity  of  dollars  in  all  varieties  of  money  through  their  exchange- 
ability, and  the  automatic  equating  of  the  value  of  the  dollar 
to  the  value  of  25.8  grains  of  gold  bullion  ;  —  these  are  the  fun- 
damental facts  of  our  monetary  system. 

Seigniorage.  —  Sovereigns  have  in  the  past  very  often  viewed 
the  monopoly  of  coinage  as  an  opportunity  for  personal  profit. 
By  calling  in  the  stock  of  metallic  money  in  the  country  for  re- 
coinage,  they  have  frequently  reduced  the  weights  of  coins  with- 
out changing  their  names,  thus  increasing  the  number  of  coins, 
so  that  a  handsome  profit  was  netted  for  the  royal  treasury. 
Debasement  of  the  cur^-^v  was  a  favorite  financial  expedient 


256  OUTLINES  OF   ECONOMICS 

of  Henry  VIII,  of  England,  and  of  Philip  the  Fair  and  Louis  XIV, 
of  France. 

Somewhat  less  reprehensible  In  theory,  although  amounting  to 
about  the  same  thing  in  its  effects,  was  the  common  practice  of 
making  a  charge  for  the  coinage  of  standard  money,  called 
seigniorage.  This  practice  was  based  on  the  idea  that  it  was 
possible  to  maintain  a  difference  between  the  value  of  a  coin  and 
the  value  of  the  bullion  put  into  it.1  A  great  deal  has  been 
written  about  the  possibility  of  seigniorage,  for  the  subject  is  one 
that  involves  considerations  that  are  fundamental  in  monetary 
theory.  It  has  been  often  said,  for  example,  that  it  is  the 
"  government  stamp,"  rather  than  the  metallic  content,  that 
gives  value  to  a  coin.  Leaving  aside  the  matter  of  limited  or 
subsidiary  coinage  (which  will  be  considered  presently),  we  may 
dispose  of  this  statement  by  saying  that  if  it  means  that  the  use 
of  certain  metals  as  money  creates  a  demand  for  them  that  would 
not  otherwise  exist  and  thus  increases  their  value,  it  is  a  truism  ; 
but  if  it  means  that  in  coinage  we  can  add  an  arbitrary  and  in- 
tangible element  of  value  to  the  value  of  the  metallic  content 
of  standard  coins,  the  statement  is  a  misleading  doctrine  that 
has  been  disproved  by  the  monetary  experience  of  almost  every 
country. 

There  is,  however,  a  stronger  statement  of  the  theory  of  seign- 
iorage. If  the  only  way  in  which  I  can  convert  bullion  into  a 
medium  of  exchange  is  by  being  content  with  750  ounces  of 
money  for  every  1000  ounces  of  bullion  I  take  to  the  mint,  will 
not  the  coins  have  a  value  one  third  greater  than  that  of  the 
metal  they  contain?  May  not  their  "metallic  content"  be 
said  to  be,  in  a  figurative  sense,  one  third  more  than  their  weight 
because  they  cost  me  that  much  more  in  bullion  ?  If  their  bul- 
lion value  sinks  below  this  point,  bullion  will  not  be  brought  to 
the  mint,  as  it  will  be  worth  more  than  the  coins  one  can  get 
for  it ;  just  as  when  the  value  of  the  coins  rises  above  this  point 
the  supply  of  bullion  would  be  stimulated  so  that  as  a  result  the 
value  of  the  coins  would  tend  to  maintain  this  fixed  relation 

1  Under  Philip  the  Fair,  the  seigniorage  charge  went  as  high  as  50  per  cent- 
Charges  of  from  2  to  15  per  cent  were  more  common. 


MONEY  257 

to  the  value  of  bullion.  As  a  matter  of  fact,  it  is  probable  that  in 
a  completely  isolated  community  a  strong  and  stable  govern- 
ment could,  through  wise  and  careful  regulations,  maintain  a 
constant  rate  of  profit  on  the  coinage,  without  endangering  the 
stability  of  the  monetary  system. 

The  fundamental  difficulty  with  seigniorage,  however,  was 
found  in  practice  to  be  that  in  foreign  trade  coins  passed  current 
only  as  bullion,  so  that  when  seigniorage  was  charged,  the  prices 
of  imported  goods,  expressed  in  money,  were  necessarily  higher 
than  their  prices  expressed  in  bullion,  by  an  amount  equal  to 
the  seigniorage.  It  was  impossible  that  one  ratio  of  exchange 
could  long  be  maintained  between  coined  money  and  bullion  in 
domestic  trade  and  another  ratio  of  exchange  in  foreign  trade. 
The  interdependence  of  the  prices  of  all  kinds  of  goods  prevented 
that.  Money  prices,  in  general  always  rose ;  that  is,  the  value 
of  the  coins  sank  to  the  level  of  the  value  of  the  bullion  they 
contained.  Under  these  conditions  no  one  would  voluntarily 
undergo  the  loss  inseparable  from  taking  bullion  to  the  mint 
for  coinage,  and  with  the  cessation  of  coinage  the  profits  from 
coinage  stopped.  Every  possible  expedient,  short  of  the  abso- 
lute prohibition  of  foreign  trade,  was  tried  by  sovereigns  in  their 
efforts  to  retain  their  profits.1  But  market  forces  were  found  to 
be  stronger  than  royal  regulations,  which  at  best  only  served  to 
retard  somewhat  the  depression  in  the  value  of  the  official  coin- 
age. About  the  only  effective  way  of  getting  profits  from  the 
coinage  was  for  the  sovereign  to  admit  that  the  coins  in  circula- 
tion possessed  only  their  bullion  value,  and  then  to  call  in  the 
currency  for  recoinage  into  smaller  pieces,  in  the  manner  that 
has  already  been  mentioned,  thus  starting  afresh  with  a  new 


1  The  use  of  any  other  circulating  medium  than  the  official  one  was  prohibited ; 
no  one  was  allowed  to  sell  imported  gold  or  silver,  whether  in  bullion  or  coin,  save 
to  the  royal  mint ;  if  there  were  mines  within  the  country,  they  were  sometimes 
prohibited  from  disposing  of  their  products  except  to  the  royal  mint;  goldsmiths 
were  forbidden  to  melt  down  coin  or  to  purchase  more  bullion  than  they  needed,  and 
this  they  were  forbidden  to  buy  at  less  than  the  mint  price ;  restrictions  were  placed 
on  the  export  of  bullion ;  these  and  other  similar  methods  were  tried,  but  all  to  no 
avail.  Cf.  W.  Lexis,  article  "Miinzwesen,"  in  H ' andworkrbuch  der  Staatswissen- 
schajten. 


258  OUTLINES  OF  ECONOMICS 

seigniorage  charge.  The  result  was  invariably  a  repetition  of  the 
process  of  a  more  or  less  rapid  depreciation  in  the  purchasing 
power  of  the  coins,  leading  often  to  further  debasements  of  the 
currency. 

Modern  nations  have  abandoned  the  attempt  to  secure  profits 
from  their  monopoly  of  the  coinage.  Since  1666  England  has 
made  no  charge  whatever  for  coining  bullion  into  standard 
money.1  Most  of  the  countries  of  continental  Europe  make  a 
charge  just  sufficient  to  cover  the  expense  of  coinage.  This 
charge  is  sometimes  called  seigniorage,  but  it  is  usually,  a'ld 
more  properly,  called  brassage.  The  United  States  made  no 
coinage  charge  until  1853,  when  a  charge  of  one  half  of 
1  per  cent  was  made  for  coining  standard  money.  This  was 
reduced  in  1873  and  was  abandoned  entirely  in  1875.  At  pres- 
ent the  United  States  exchanges  gold  coins,  weight  for  weight, 
for  bullion  of  standard  fineness  (nine  tenths  gold,  one  tenth  cop- 
per) brought  to  the  mint  in  lots  of  one  hundred  dollars  or  more 
in  value.  For  crude  bullion,  or  bullion  not  of  standard  fineness, 
gold  coins  are  exchanged  containing  as  much  fine  gold  as  is 
contained  in  the  bullion,  less  a  trifling  charge  for  assaying,  re- 
fining, and  for  the  alloy.2 

Instead  of  viewing  coinage  as  a  profitable  prerogative  of  the 
government,  we  have  come  to  view  it  as  a  government  duty,  to  be 
performed  at  government  expense.  The  question  of  seigniorage 
versus  gratuitous  coinage  is  no  longer  a  live  issue.  But  the  stu- 
dent who  has  grasped  the  significance  of  the  lesson  contained  in 


1  In  practice  most  of  the  gold  bullion  coined  in  England  is  supplied  to  the  mint 
by  the  Bank  of  England,  which  is  required  by  law  to  purchase  it  at  the  minimum 
price  of  £3  175.  gd.  per  ounce.  An  ounce  of  bullion  makes  £3  17s.  iojd.  in  gold 
coin,  the  difference  going  to  compensate  the  bank  for  the  delay  involved  in  getting 
the  bullion  coined  at  the  mint.  In  the  United  States  the  waiting  devolves  upon 
the  government,  for  gold  coins,  or,  at  the  option  of  the  depositor,  checks  upon 
United  States  subtreasuries  or  upon  depository  banks  are' paid  to  depositors  as  soon 
as  their  bullion  can  be  weighed  and  assayed. 

2  The  coinage  mints  are  at  Philadelphia,  San  Francisco,  and  Denver.  In  addi- 
tion there  are  bullion-purchasing  mints  (not  now  operated  as  coinage  mints)  at 
New  Orleans  and  Carson  City,  and  assay  offices  at  New  York,  Boise,  Helena,  St. 
Louis,  Deadwood,  Salt  Lake  City,  and  Seattle,  which  receive  bullion  on  the  same 
terms  as  the  mints,  plus  an  additional  <  harge  of  one  eighth  of  1  per  cent. 


MONEY  259 

the  history  of  seigniorage  has  taken  an  important  step  toward 
the  understanding  of  monetary  theory.  The  coinage  of  standard 
money  is  now  in  law,  and  always  has  been  in  fact,  a  device  for 
dividing  the  standard  money  metal  into  convenient  units  of  cer- 
tified weight  and  fineness. 

Limited  Coinage.  —  Gold  is  the  only  metal  which  is  made  into 
coins  by  the  United  States  government  for  any  one  who  deposits 
bullion  at  the  mints  or  assay  offices.  All  other  coins  are  made 
from  metal  purchased  from  time  to  time  for  that  purpose  as  Con- 
gress may  direct.  In  none  of  these  coins  is  the  bullion  worth  as 
much  as  the  coin.  In  1878,  when  the  United  States  began  the 
limited  coinage  of  silver  dollars,  the  value  of  the  37 1|  grains  of 
pure  silver  in  a  silver  dollar  was  about  89  cents.  The  value  of 
silver  declined  steadily  until  1902,  when  371 1  grains  of  silver  were 
worth  only  41  cents.  Since  that  time  there  has  been  a  slight 
upward  movement,  but  nevertheless  in  191 5  the  bullion  value  of 
a  silver  dollar  was  only  about  one  half  its  value  as  a  coin.  The 
bullion  value  of  the  smaller  silver  coins  is  still  less,  for  they  con- 
tain but  347.22  grains  of  silver  to  the  dollar,  while  the  bullion 
value  of  our  nickel  and  bronze  coins  is  yet  smaller,  relatively. 

Such  coins  are  sometimes  called  "  token  coins,"  the  implica- 
tion being  that  the  fact  that  they  pass  from  hand  to  hand  at  their 
full  nominal  value  is  merely  a  matter  of  habit  or  usage,  supported 
by  general  acquiescence.  More  accurately,  however,  they  are 
credit  coins,  because  the  excess  of  their  coin  value  over  their 
bullion  value  depends  ultimately,  as  we  have  seen,  upon  the  good 
faith  and  credit  of  the  government,  evidenced  by  their  redeem- 
ability  in  gold.  If,  for  example,  a  catastrophe  should  overthrow 
the  present  federal  government,  and  if  the  new  government 
should  refuse  to  recognize  the  obligations  of  the  old,  nothing 
could  prevent  these  coins  from  sinking  to  their  bullion  value. 

A  very  considerable  profit  accrues  to  the  government  from  this 
limited  coinage.  The  difference  between  the  amount  paid  for 
silver  bullion  from  1878  to  1907,  and  the  value  of  the  coins  made 
from  it,  amounted  to  $143,000,000.  In  the  accounts  of  the  fed- 
eral treasury  this  profit  is  called  seigniorage,  but  it  should  be 
carefully  distinguished   from  real   seigniorage,  —  a  charge  ex- 


260  OUTLINES  OF  ECONOMICS 

acted  for  the  conversion  of  standard  bullion  into  standard  coin. 
If  the  federal  government  should  issue  a  general  balance  sheet  of 
the  kind  used  in  corporation  accounting,  the  credit  element  in 
its  outstanding  limited  coinage  would  properly  appear  as  a  liabil- 
ity, which  might  be  greater  or  less  than  the  profits  that  had  ac- 
crued on  such  coinage,  depending  upon  whether  the  present  value 
of  the  bullion  in  the  coins  happened  to  be  greater  or  less  than  the 
prices  which  the  government  had  paid  for  it. 

Bimetallism.  —  A  monetary  system  like  the  present  one  of  the 
United  States  is  a  single  standard  system,  because  only  one  com- 
modity is  used  as  a  monetary  standard.  The  double  standard  sys- 
tem, under  which  two  different  commodities  serve  concurrently 
as  legal  monetary  standards,  has,  however,  been  used  in  the  past 
by  many  governments,  including  our  own,  and  its  superiority 
over  the  single  standard  system  has  been  alleged  by  many  advo- 
cates. Practically  the  only  commodities  that  civilized  nations 
have  used  as  monetary  standards  in  modern  times  are  gold  and 
silver.  The  question  of  the  double  standard  resolves  itself, 
accordingly,  into  the  question  of  the  bimetallic  standard,  which 
means  in  practice  the  unlimited  coinage  of  both  gold  and  silver. 

Bimetallism  does  not  mean,  in  theory,  as  might  be  supposed, 
the  establishment  of  two  different  monetary  units  of  different 
names,  one  denned  as  a  certain  amount  of  silver,  the  other  de- 
fined as  a  certain  amount  of  gold,  prices  being  stated  accord- 
ing to  convenience  in  terms  of  either  unit.  On  the  contrary, 
it  contemplates  the  establishment  of  one  nominal  unit,  such  as 
the  dollar,  to  be  defined  at  the  same  time  as  either  a  definite 
amount  of  gold  or  a  definite  amount  of  silver.  More  concretely, 
this  means  the  opening  of  the  mints  to  the  unlimited  coinage  of 
both  gold  and  silver  into  dollars,  or  dollar  multiples,  the  amount 
of  silver  in  a  silver  dollar  and  the  amount  of  gold  in  a  gold  dollar 
being  established  by  law. 

Many  of  the  arguments  that  have  been  advanced  by  bimetal- 
lists  have  related  to  the  alleged  immediate  advantages  to  be 
secured  from  the  adoption  of  the  double  standard  under  particu- 
lar conditions  of  time  and  place.  One  argument,  however,  of 
more  general  significance  is  based  on  the  probable  greater  stabil- 


MONEY  261 

ity  of  prices  under  the  double  standard.  Silver  and  gold  are  pro- 
duced under  somewhat  different  conditions,  and  are  used  for 
somewhat  different  purposes.  It  has  been  maintained  that 
tendencies  toward  fluctuations  in  prices  stated  in  silver  and  in 
prices  stated  in  gold  would,  therefore,  be  as  apt  to  be  in  opposite 
directions  as  in  the  same  direction,  and  that  so  far  as  they  were 
in  opposite  directions  they  would  tend  to  counterbalance  each 
other. 

Most  opponents  of  bimetallism,  while  admitting  that,  if 
feasible,  it  might  possess  some  advantages,  deny  its  possibility. 
The  difficulty  is,  they  maintain,  that  while  the  ratio  of  the  weight 
of  gold  in  the  monetary  unit  to  the  weight  of  silver  in  the  mone- 
tary unit  has  to  be  fixed  and  definite,  the  ratio  at  which  gold 
exchanges  for  silver  is  not  fixed  and  definite,  but  is  subject  to  the 
fluctuations  of  the  market.  If  one  metal  is  relatively  underap- 
praised  and  the  other  relatively  overappraised  by  the  legal  ratio, 
the  result  will  be  that  only  the  overappraised  metal  will  be 
brought  to  the  mint  for  coinage,  for  the  underappraised  metal 
will  be  worth  no  more  than  the  overappraised  one  as  coin,  but 
will  be  worth  more  as  bullion.  The  actual  result  will  be,  in  such 
a  case,  not  a  bimetallic  standard,  but  a  single  standard  composed 
of  the  metal  which,  at  the  mint  ratio,  is  the  cheaper.  Moreover, 
if,  by  a  change  in  the  market  ratios  of  exchange  of  the  two  metals, 
this  one  in  turn  becomes  underappraised  by  the  mint  ratio,  the 
standard  coins  composed  of  that  metal  that  are  already  in  use 
will  disappear  from  circulation,  being  hoarded,  melted  down,  or 
exported,  and  the  other  metal  will  take  its  place  as  the  actual 
standard  of  value. 

The  opponents  of  bimetallism  claim,  in  short,  that  it  en- 
counters a  formidable  obstacle  in  the  principle  known  as 
GreshamJs  law,  which  is  usually  summarized  with  rough  accuracy 
in  the  statement  that  "  bad  money  drives  out  good,"  or  that 
"  the  cheaper  money  drives  out  the  dearer."  More  definitely, 
this  means  that  domestic  payments  will  be  made,  as  far  as  pos- 
sible, in  the  money  which  can  be  used  to  less  advantage  for  other 
purposes,  and  that  no  one  will  exchange  relatively  expensive 
bullion  for  coins  at  the  mint  when  coins  of  an  equal  nominal 


262  OUTLINES  OF   ECONOMICS 

value  and  (for  most  purposes)  of  equal  purchasing  power  can  be 
obtained  in  exchange  for  relatively  cheaper  bullion.  Sir  Thomas 
Gresham  is  said  to  have  come  to  this  conclusion  as  a  result  of 
his  observations  of  the  difficulties  encountered  by  Queen  Eliza- 
beth in  her  attempts  to  improve  the  condition  of  the  debased, 
worn,  and  mutilated  coinage  bequeathed  to  her  by  her  prede- 
cessors. But  the  operation  of  the  principle  had  previously  been 
noted  by  various  writers. 

All  but  the  most  extreme  bimetallists  would  admit  the  impossi- 
bility of  establishing  and  maintaining  a  coinage  ratio  between  the 
two  metals  that  would  differ  by  any  wide  margin  from  the  initial 
ratio  at  which  they  exchanged  in  the  market,  but  they  maintain 
that  a  mint  ratio  established  as  nearly  as  possible  to  the  prevail- 
ing market  ratio  will  have  a  steadying  influence  upon  the  latter 
that  will  tend  to  prevent  any  wide  divergence  between  the  two. 
If  the  market  ratio  should  change  to  such  an  extent  that  it 
would  not  pay  to  use  one  of  the  metals  as  money,  more  of  the  other 
metal  would  be  used  for  monetary  purposes,  thus  decreasing 
the  supply  of  it  available  for  other  uses  and  consequently  en- 
hancing its  relative  value.  The  net  effect  of  this  "  compensa- 
tory action  of  bimetallism"  would  be,  it  is  claimed,  a  tendency 
toward  the  equilibrium  of  the  market  ratio  of  exchange  of  the 
two  metals  at  the  coinage  ratio. 

The  appeal  to  history  has  been  used  both  by  bimetallists  and 
their  opponents.  The  claim  of  the  monometallists  that  legal  bi- 
metallism is  apt  to  mean  actual  monometallism,  with  the  rela- 
tively cheaper  metal  as  the  standard,  has  been  substantiated 
many  times  in  the  monetary  experience  of  different  nations. 
The  automatic  change  from  one  single  standard  to  the  other, 
following  a  change  in  market  rates  of  exchange,  is  also  a  phenom- 
enon that  has  been  illustrated  by  a  large  number  of  concrete 
cases.  On  the  other  hand,  the  bimetallists  are  able  to  point 
to  some  fairly  successful  bimetallic  systems,  such  as  that  of 
France  in  the  first  half  of  the  nineteenth  century.  But  it  is  a 
significant  fact  that  no  real  bimetallic  system  has  been  able  to  en- 
dure for  any  considerable  time  except  when  the  annual  produc- 
tion of  gold  and  silver  was  relatively  small  and  relatively  stable. 


MONEY  263 

and  where  international  trade  was  a  relatively  unimportant  item. 
There  is  no  scientific  student  of  monetary  problems  who  believes 
that  it  would  be  possible  for  any  nation  independently  to  main- 
tain the  double  standard  under  the  present  conditions  of  a  large 
and  fluctuating  annual  production  of  the  precious  metals,  coupled 
with  an  international  commerce  of  vast  proportions. 

International  bimetallism,  that  is,  the  adoption  by  most  of  the 
leading  nat  ions  of  a  bimetallic  standard,  at  a  ratio  fixed  by  inter- 
national agreement,  has  had  many  supporters,  even  among  those 
who  do  not  believe  in  the  practicability  of  national  bimetallism, 
and  representatives  of  different  nations  have  assembled  in  several 
international  monetary  conferences  for  the  discussion  of  this 
subject.  International  bimetallism  would  remove  one  difficulty 
experienced  in  the  attempts  made  by  different  nations  to  main- 
tain independent  bimetallic  systems  at  even  slightly  differing 
ratios,  — ■  and  that  is  the  tendency  for  each  metal  to  flow  from 
the  countries  in  which  it  is  relatively  underappraised  in  the  mint 
ratio  to  the  countries  in  which  it  is  relatively  overappraised. 
Other  difficulties,  however,  would  still  remain,  and  the  possi- 
bility of  maintaining  an  actual  bimetallic  standard  even  under 
international  agreement,  supposing  that  were  possible,  is  open 
to  very  serious  doubt. 

The  waning  of  public  interest  in  the  question  of  bimetallism  in 
recent  years  is  of  great  significance,  because  it  indicates  that  the 
real  moving  forces  behind  the  bimetallist  propaganda  have  not 
been  any  real  or  assumed  points  of  superiority  of  general  sig- 
nificance that  may  be  imputed  to  a  double  standard,  but  rather 
that  certain  specific  results  that  would  flow  from  the  adoption  of 
bimetallism  at  a  particular  time  and  place  have  been  desired. 
More  specifically,  bimetallism  has  been  supported  by  those  who 
have  desired  "  cheaper  money,"  and  these  have  been  particu- 
larly active  when  the  money  in  actual  use  has  been  increasing 
in  its  purchasing  power,  that  is,  when  prices  in  general  have  been 
decreasing.  The  recent  great  increase  in  the  world's  production 
of  gold  has,  temporarily  at  least,  taken  bimetallism  out  of  the 
list  of  economic  problems  of  general  public  interest. 

Bimetallism  in  the  United  States.  —  The  national  monetary 


264  OUTLINES  OF  ECONOMICS 

system  was  established  by  act  of  Congress  in  1792.1  The  mint 
was  opened  to  the  free  and  unlimited  coinage  of  both  gold  and 
silver,  the  silver  coins  containing  371^  grains  of  fine  metal  per 
dollar,  and  the  gold  coins  24!  grains  per  dollar,  the  ratio  of  15 
to  1  being  thus  established.  It  was  soon  found,  however,  that 
gold  was  worth  in  the  market  slightly  more  than  fifteen  times  as 
much  silver,  and  as  a  consequence  but  little  gold  was  brought 
to  the  mint  for  coinage,  while  such  gold  as  was  coined  illustrated 
Gresham's  law  by  speedily  disappearing  from  circulation. 

Silver  dollars,  too,  disappeared  from  circulation,  but  for  another  reason. 
They  were  somewhat  lighter  than  the  Spanish  dollars  which  were  in  general 
circulation  at  the  time,  and  would,  under  the  operations  of  Gresham's  law, 
have  driven  the  latter  out  of  circulation,  had  it  not  been  that  the  Spanish 
dollar  commanded  a  slight  premium  over  the  American  dollar  in  ordinary 
purchases.  But  the  American  dollars,  on  account  of  their  new  and  attractive 
appearance,  could  be  used  as  advantageously  as  the  Spanish  dollars  in  trade 
with  the  Spanish  possessions  in  America.  They  were  consequently  taken 
from  the  country  for  that  purpose,  while  Spanish  dollars  were  brought  back 
and  were  sometimes  recoined  into  a  larger  number  of  American  dollars. 
This  wasteful  coinage  of  silver  dollars  was  stopped  in  1806  by  order  of 
President  Jefferson,  leaving  the  mint  open  to  the  coinage  only  of  gold,  smaller 
silver  coins,  and  minor  coins.  As  a  matter  of  fact  American  coins  made  up 
only  an  insignificant  part  of  our  circulating  medium  before  1834. 

Realizing  the  impossibility  of  maintaining  a  gold  coinage  under 
such  conditions,  Congress,  in  1834,  changed  the  legal  ratio  to 
16  to  1  by  reducing  the  weight  of  the  gold  dollar.  By  this  step, 
however,  it  went  too  far  in  the  other  direction,  for  gold  was  not 
worth  in  the  market  quite  sixteen  times  as  much  as  silver,  and 
while  the  number  of  gold  coins  increased,  but  little  silver  was 
brought  to  the  mint,  and  silver  coins  quickly  disappeared  from 
circulation.  In  order  to  secure  a  supply  of  small  change,  Con- 
gress was  forced,  in  1853,  to  abandon  the  principle  of  the  un- 

1  The  act  of  1702  followed  in  detail  the  recommendations  of  a  Report  on  the 
Establishment  of  a  Mint,  by  Alexander  Hamilton,  then  Secretary  of  the  Treasury. 
Hamilton  incorporated  some  of  the  recommendations  contained  in  earlier  reports 
by  Robert  Morris  and  Thomas  Jefferson.  Hamilton's  Report  has  been  frequently 
reprinted,  but  it,  together  with  the  reports  of  Morris  and  Jefferson  and  other  perti- 
nent documents,  may  be  conveniently  found  in  the  Report  of  the  International 
Monetary  Conjcrcncc  of  1878. 


MONEY  265 

limited  coinage  of  silver  coins  smaller  than  a  dollar,  and  to  order 
that  they  should  be  coined,  as  at  present,  only  from  bullion 
purchased  by  the  government  at  the  market  price.  At  the  same 
time  the  weight  of  these  subsidiary  coins  was  reduced  by  one 
seventh  to  insure  their  being  retained  in  circulation. 

The  discovery  of  gold  in  California,  in  1848,  and  in  Australia, 
in  1851,  suddenly  increased  the  world's  supply  of  gold  by  an 
unprecedented  amount.  In  fact,  the  careful  estimates  of  Dr. 
Soetbeer  indicate  that  as  much  gold  was  produced  in  the  third 
quarter  of  the  nineteenth  century  as  in  the  preceding  three  cen- 
turies and  a  half  following  the  discovery  of  America.  The  result 
was  to  increase  the  discrepancy  between  the  mint  ratio  and  the 
actual  market  ratio  of  exchange  of  gold  and  silver,  although  the 
production  of  silver  had  also  been  greatly  increased.  Gold  was 
brought  to  the  mint  for  coinage  in  enormous  amounts  —  a  con- 
dition that  lasted  even  after  1861,  when  paper  currency  began  to 
be  used  almost  exclusively  as  the  medium  of  exchange. 

In  a  general  revision  of  the  coinage  laws,  enacted  in  1873,  the 
silver  dollar  was  dropped  from  the  list  of  coins  that  could  be 
manufactured  at  the  mint.  Although  this  action  was  almost  un- 
noticed at  the  time,  a  fictitious  significance  has,  in  subsequent 
years,  been  attached  to  it.  Silver  was  practically  "  demone- 
tized," that  is,  its  free  and  unlimited  coinage  was  actually  pre- 
vented, by  the  establishment  of  the  ratio  of  16  to  1  in  1834.  The 
act  of  1873  gave  legal  recognition  to  an  existing  fact. 

But  a  sudden  depreciation  in  the  value  of  silver,  which  began 
at  about  this  time,  brought  the  question  of  bimetallism  again 
into  the  foreground.  Since  the  seventeenth  century  the  market 
ratios  of  gold  and  silver  had  fluctuated  only  between  relatively 
narrow  margins,  and  in  no  year  since  the  establishment  of  the 
United  States  mint  had  the  average  annual  price  of  an  ounce  of 
gold  been  less  than  15  or  more  than  i6|  times  the  price  of  an 
ounce  of  silver.  In  1875,  however,  the  market  ratio  fell  to  16 
to  1 ;  by  1878  it  was  18  to  1 ;  by  1886  it  was  20.8  to  1 ;  and  in 
1894  it  was  32.6  to  i.1     It  is  evident  that  if  the  opportunity  for 

1  The  causes  of  this  unprecedented  decline  in  the  relative  value  of  one  of  the 
precious  metals  were  complex  and  intricate.    The  following  may  be  mentioned, 


266  OUTLINES  OF  ECONOMICS 

the  free  and  unlimited  coinage  of  silver  at  the  ratio  of  16  to  i 
had  still  existed,  there  would  have  been  another  sudden  change 
in  the  actual  monetary  standard.  Gold  would  have  been  under- 
appraised  by  that  ratio,  and  would  have  disappeared  from  cir- 
culation, and  silver  would  have  taken  its  place.  It  was  the 
realization  of  this  fact,  coupled  with  the  knowledge  that  the 
silver  standard  would  mean  a  "  cheaper  dollar,"  that  led  to  a  pop- 
ular agitation  for  the  free  and  unlimited  coinage  of  silver  which 
continued  for  more  than  twenty  years. 

The  first  tangible  result  of  this  agitation  was  a  compromise 
measure,  the  Bland- Allison  Act,  passed  by  Congress  in  1878, 
which  instituted  the  limited  coinage  of  silver  dollars  by  authoriz- 
ing the  Secretary  of  the  Treasury  to  purchase  at  market  prices 
not  less  than  $2,000,000  nor  more  than  $4,000,000  worth  of  silver 
bullion  per  month,  and  to  coin  it  into  dollars.  The  results  of 
this  enforced  coinage  were  satisfactory  to  neither  party  to  the 
controversy.  The  amount  of  silver  coined  was  in  excess  of  the 
demand  for  that  bulky  kind  of  money,  even  though  as  much  as 
possible  was  put  into  circulation  in  the  form  of  silver  certificates, 
and  although  the  government  tried  to  favor  the  distribution  of 
silver  by  paying  the  expense  of  transporting  it  to  the  localities 
where  it  was  wanted.  The  movement  in  favor  of  the  unlimited 
coinage  of  silver  continued  to  gain  in  strength,  however,  its  ad- 
vocates claiming  that  "  more  silver,"  rather  than  less,  was 
needed. 

A  second  compromise  was  effected  in  the  Sherman  Silver-Pur- 
chase Act  of  1890,  which  provided  for  an  increase  in  the  amount 
of  silver  purchased  to  4,500,000  ounces  each  month,  which  was 
to  be  paid  for  in  treasury  notes.  These  treasury  notes  were 
to  be  full  legal  tender,  and  were  redeemable  in  gold  or  silver  coin 
at  the  discretion  of  the  Seoretary  of  the  Treasury.  The  silver 
was  to  be  coined  only  so  rapidly  as  was  found  necessary  for  the 
redemption  of  the  treasury  notes.     The  increase  in  the  amount 

however,  as  contributing  circumstances:  (i)  Cessation  of  an  extraordinary  de- 
mand for  silver  in  India  which  had  existed  since  1850;  (2)  Stoppage  of  the  unlim- 
ited coinage  of  silver  in  several  European  countries;  (3)  Discovery  of  large  silver 
mines  in  the  United  States;  (4)  Increase  in  the  value  of  gold,  as  evidenced  by  a 
general  decrease  in  the  prices  of  commodities. 


MONEY  267 

of  silver  purchased  was  a  concession  to  the  advocates  of  the  un- 
limited coinage  of  silver ;  the  fact  that  the  circulating  medium 
based  immediately  on  these  purchases  was  composed  of  treasury 
notes,  which  were  injected  into  circulation  in  proportion  to  the 
market  price  of  the  silver  purchased,  was  a  concession  to  their 
opponents. 

The  soundness  of  the  principles  embodied  in  the  Sherman  Act 
was  soon  tested  by  a  period  of  financial  and  industrial  depression. 
Gold  had  to  be  exported  to  Europe  in  large  quantities  to  settle  an 
adverse  balance  of  trade,  and  the  government  found  difficulty  in 
maintaining  its  own  gold  reserve,  which  was  already  seriously 
threatened  by  a  decline  in  customs  receipts,  accompanied  by  an 
increase  in  federal  expenditures.  The  gold  reserve  was  at  that 
time  simply  the  amount  of  gold  in  the  treasury  that  was  available 
for  the  redemption  of  other  forms  of  money,  —  especially  the 
United  States  notes,  or  greenbacks,  that  had  been  first  issued 
during  the  Civil  War,  but  which  did  not  become  actually  redeem- 
able in  gold  until  1879.  During  this  scarcity  of  gold  the  banks 
were  able  to  secure  gold  for  their  own  reserves  or  for  export  by 
presenting  United  States  notes  at  the  treasury  for  redemption 
in  gold.  Under  the  law  the  notes  had  to  be  immediately  reis- 
sued, and  were  used  in  government  payments,  but  no  sooner 
was  this  done  than  they  were  again  returned  by  the  banks  for 
redemption  in  gold. 

The  workings  of  this  "  endless  chain  "  by  which  gold  was 
pumped  from  the  government  treasury  were  aggravated  by  the 
fact  that  the  treasury  notes  authorized  by  the  Sherman  Act  were 
used  for  the  same  purpose.  Although  they  were  payable  either 
in  gold  or  silver  coin,  they  were  actually  redeemed  on  demand 
in  gold.  This  was  at  the  urgent  insistence  of  President  Cleve- 
land, who  believed,  with  good  reason,  that  a  refusal  to  redeem 
them  in  gold  would  probably  have  forced  the  silver  standard 
upon  us,  by  destroying  the  exchangeability  of  silver  and  gold 
and  thus  putting  an  end  to  their  parity,  and  that  it  would  cer- 
tainly have  injured  the  credit  of  the  government  and  put  it  to 
a  disadvantage  in  the  bond  sales  that  were  needed  to  replenish 
the  gold  reserve.     Under  the  operations  of   the  Sherman  Act 


268  OUTLINES  OF  ECONOMICS 

the  government  was  virtually  exchanging  gold  coin  for  silver 
bullion  at  a  time  when  gold  was  sorely  needed  when  the  gold 
value  of  the  purchased  silver  was  steadily  depreciating. 

The  gold  reserve  sank  from  $190,000,000  in  1890  to  $95,000,000 
in  1893.  In  June  of  the  latter  year  the  closing  of  the  mints  of 
India  to  the  unlimited  coinage  of  silver  gave  an  added  impetus 
to  the  downward  movement  of  the  price  of  that  metal.  These 
facts  led  Congress,  in  a  special  session  called  in  1893  for  that 
purpose,  to  order,  though  with  obvious  reluctance,  that  the  pur- 
chase of  silver  under  the  Sherman  Act  should  be  stopped. 

The  agitation  for  the  free  and  unlimited  coinage  of  silver  continued, 
however,  and  with  increased  vigor,  and  it  was  made  the  sole  issue  in  the 
presidential  campaign  of  1896.  It  was  alleged  that  the  yet  continuing  indus- 
trial depression  could  be  alleviated  only  by  "more  money"  and  "cheaper 
money."  It  was  claimed  by  many  intelligent  people  that  the  unlimited 
coinage  of  silver  would  not  drive  gold  from  circulation,  but  would  increase 
the  value  of  silver  and  decrease  the  value  of  gold  until  they  met  at  a  parity 
established  by  the  desired  legal  ratio  of  16  to  1.  The  most  effective  argu- 
ment of  the  protagonists  of  silver  was  found,  however,  in  the  admitted  fact 
that  the  value  of  gold,  as  shown  by  changes  in  the  general  price  level,  had 
been  increasing.  All  indications  pointed  toward  a  continued  decrease  in 
the  annual  production  of  gold,  and  a  consequent  further  decrease  in  prices. 
This,  it  was  argued,  was  a  hardship  to  those  who  had  borrowed  money  on 
long  time  obligations,  such  as  mortgages,  because  they  would  be  forced  to 
repay  in  value  or  purchasing  power  more  than  they  had  borrowed.1 

This  agitation  was,  in  fact,  simply  one  of  a  series  of  cheap  money  move- 
ments that  have  characterized  the  economic  development  of  the  United 
States,  and  which  have  sprung  from  the  fact  that  the  opening  up  and  develop- 
ing of  new  lands  have  called  for  expenditures  in  amounts  far  beyond  the 
resources  of  the  actual  settlers.  Newly  settled  regions  have  usually  been 
debtor  regions,  and  there  is  more  than  mere  coincidence  in  the  fact  that  de- 
mands for  cheap  money  have  always  been  voiced  most  loudly  on  the  frontier.' 
This  does  not  mean  that  a  cheap  money  movement  is  essentially  dishonest ; 
that  it  represents  the  conscious  attempts  of  debtors  to  escape  the  payment 
of  their  lawful  debts.  The  life  and  vigor  in  this  movement  for  the  unlimited 
coinage  of  silver  was  put  into  it  by  men  who  saw  the  imputed  value  of  their 
assets  sinking  and  the  difficulty  of  paying  their  debts  increasing  in  a  financial 
crisis  for  which  they  were  not  individually  responsible.     Money  funds  were 

1  This  argument  raises  the  problem  of  the  standard  of  deferred  payments,  which 
Is  to  be  considered  in  Chapter  XVI. 

*Cf.  C.  J.  Bullock,  Essays  in  the  Monetary  History  of  the  United  Stales,  Part  i. 


MONEY  269 

hard  to  get  because  personal  credit,  the  foundation  of  bank  credit,  was 
lacking.  This  scarcity  of  money  funds  was  confused,  naturally,  if  erro- 
neously, with  the  scarcity  of  "money"  in  the  sense  of  standard  money,  — 
gold;  and  the  remedy  was  sought  in  an  action  that  would  give  more  and 
cheaper  standard  money. 

The  defeat  of  the  advocates  of  bimetallism  in  1896  would  probably  not 
have  stopped  the  agitation  for  the  unlimited  coinage  of  silver,  had  it  not  been 
for  the  return  of  prosperous  conditions,  coupled  with  an  enormous  increase 
in  the  world's  annual  production  of  gold,  which  has  brought  with  it  a  general 
increase  in  prices. 

The  single  gold  standard  was  formally  and  definitely  recog- 
nized by  law  in  1900.  All  of  the  silver  bullion  purchased  under 
the  Sherman  Act  has  been  coined,  and  silver  dollars  sufficient  in 
amount  to  retire  the  treasury  notes  have  been  set  aside  for  that 
purpose.  These  treasury  notes  (which  should  not  be  confused 
with  the  United  States  notes,  or  greenbacks)  are  accordingly  on 
substantially  the  same  basis  as  silver  certificates.  Up  to  June 
30,  191 5,  their  amount  had  been  reduced  from  $156,000,000  to 
$2,250,000.  No  silver  dollars  have  been  coined  since  1904,  and 
under  the  present  law  no  more  can  be  coined  unless  Congress 
should  authorize  the  special  purchase  of  bullion  for  that  purpose. 

The  Gold-Exchange  Standard.  —  Within  the  past  twenty 
years  gold  has  been  accepted  more  generally  and  more  definitely 
than  ever  before  as  the  standard  money  metal  of  the  world.  The 
change  from  a  silver  standard  to  the  gold  standard  is  often  a 
difficult  and  expensive  national  undertaking,  but  it  brings  the 
advantages  of  a  more  stable  unit  of  value  and  of  increased 
facility  in  making  international  payments.  In  191 5  the  silver 
standard  prevailed  only  in  China,  Persia,  Paraguay,  and  three 
Central  American  countries.1 

In  a  number  of  places  in  which  it  is  impossible,  for  one  reason 
or  another,  to  introduce  gold  as  part  of  the  actual  medium  of 
exchange,  the  silver  standard  has  been  replaced  by  the  gold- 
exchange  standard.  Where  this  standard  exists  the  currency 
of  the  country  consists  largely  of  silver  coins,  put  into  circula- 
tion by  a  system  of  limited  coinage.  These  coins  are  maintained 
at  a  fairly  definite  gold  value,  higher  than  that  of  their  bullion 
1  Report  of  the  Director  of  the  Mint,  in  Finance  Report,  iqis,  p.  456. 


270  OUTLINES   OF   ECONOMICS 

content.  This  is  not  accomplished,  however,  by  making  them 
always  and  necessarily  redeemable  in  fixed  quantities  of  gold. 
Instead  the  government  agrees  to  sell  exchange  on  one  or  more 
gold-using  countries  at  a  maximum  fixed  price  in  terms  of  the 
local  coins.1  That  is,  while  the  local  currency  is  not  necessarily 
redeemable  in  gold  within  the  home  country,  it  is  redeemable 
in  bills  of  exchange  or  drafts  payable  in  gold  in  some  foreign 
country.  It  is  necessary,  of  course,  for  the  home  government 
to  maintain  funds  for  this  purpose  in  a  gold-using  country.  The 
gold-exchange  standard  has  been  adopted  in  India,  the  Philip- 
pines, Mexico,  Panama,  Siam,  Indo-China,  the  Straits  Settle- 
ments, and  (in  a  modified  form)  in  Java. 

Where  carefully  administered  it  has  worked  well,  and  has 
brought  to  the  countries  using  it  practically  all  of  the  advantages 
of  the  gold  standard  without  the  expense  of  introducing  and 
maintaining  a  gold  currency  and  sometimes  without  making 
it  necessary  for  the  people  to  familiarize  themselves  with  a  new 
kind  of  money.  It  has  even  been  suggested  by  certain  writers 
that  the  great  nations  of  the  world  might  wisely  adopt  the  gold- 
exchange  standard,  making  their  local  currencies  redeemable 
at  fixed  rates  in  drafts  upon  some  one  country  in  which  the  bulk 
of  the  gold  reserves  of  the  world  would  be  kept.  A  change  like 
this  is  impracticable  so  long  as  wars,  with  their  interruptions  of 
international  commerce  and  international  gold  payments,  re- 
main possible.  Nor  would  it  be  particularly  advantageous. 
The  general  adoption  of  the  gold-exchange  standard  would,  it 
is  true,  greatly  decrease  the  amount  of  gold  needed  to  carry  on 
the  world's  business  transactions  at  present  prices.  But  the  ul- 
timate result,  there  is  good  reason  to  believe,  would  merely  be  a 

1  Since  i8g3  the  mints  of  India  have  been  closed  to  the  free  coinage  of  silver. 
Silver  rupees,  coined  from  bullion  purchased  by  the  government,  are  now  main- 
tained at  a  gold  value  of  approximately  one  shilling  and  four  pence  per  rupee  by 
the  government's  practice  of  selling,  when  necessary,  bills  of  exchange  payable  in 
London  at  a  price  not  higher  than  15.  3§j  d.  per  rupee.  The  peso  of  the  Philippines, 
containing  only  about  three  fourths  as  much  silver  as  the  silver  dollar  of  the  United 
States,  is  maintained  at  a  gold  value  of  approximately  fifty  cents  by  the  insular 
government's  accepting  it  at  that  price  (minus  a  small  charge)  in  exchange  for  drafts 
payable  in  New  York. 


MONEY  271 

general  increase  in  prices,  so  that  the  aggregate  volume  of  pay- 
ments (measured  in  money  units)  would  increase  and  more 
gold  would  be  needed  in  the  world's  gold  reserves.  The  world 
as  a  whole  does  not  profit  by  "  economizing  in  the  use  of  gold," 
even  though  particular  countries  may  be  able  to  save  by  avoid- 
ing the  expense  of  introducing  a  gold  currency. 

Government  Paper  Money.  —  In  metallic  money  of  limited 
coinage,  there  is,  as  we  have  seen,  a  considerable  element  of 
credit.  In  paper  money  the  element  of  credit  is  alone  present. 
Government  paper  money  is  composed  of  instruments  which  bind 
the  government  to  pay,  and  usually  to  pay  on  demand,  equiv- 
alent amounts  of  metallic  money,  —  usually  standard  money. 

Government  paper  money  also  differs  from  metallic  money  of 
limited  coinage  in  respect  to  the  motives  which  give  rise  to  and 
regulate  its  issue.  Subsidiary  coins  are  issued  by  the  govern- 
ment in  response  to  the  demand  for  circulating  medium  for  use 
in  small  transactions  and  in  making  change.  The  public  con- 
venience is  the  first  consideration ;  the  profit  accruing  to  the 
government  on  such  coinage  is  a  secondary  thing.  In  issuing 
government  paper  money,  however,  fiscal  motives  have  predomi- 
nated. When  hard  pressed  to  swell  the  government  income  to 
cover  an  increase  in  expenditures,  those  responsible  for  the  finan- 
cial policies  of  a  government  have  often  deemed  it  advisable  for 
the  government  to  make  use  of  its  own  notes,  promises  to  pay, 
in  discharging  its  obligations. 

These  differ  from  government  bonds,  which  are  often  issued  in 
similar  circumstances,  in  that  the  bonds  bear  interest,  are  sold  to 
voluntary  buyers,  and  are  usually  payable  at  a  definite  time  in 
the  future,  while  government  notes  are  usually  non-interest 
bearing,  represent  a,  forced  rather  than  a  voluntary  loan,  and  are 
usually,  in  form  at  least,  payable  on  demand,  or  in  practice,  at  an 
indefinite  time  in  the  future.  They  are,  moreover,  issued  in 
convenient  form  for  monetary  use,  and  are  usually  made  legal 
tender,  so  that  they  pass  from  hand  to  hand  as  a  medium  of  ex- 
change. The  forced  loan  which  they  represent  is  therefore 
shifted  from  those  who  first  receive  the  notes  from  the  govern- 
ment for  their  goods  or  their  services. 


272  OUTLINES  OF  ECONOMICS 

Colonial  and  Revolutionary  Bills  of  Credit.  —  Paper  money 
issues  have  frequently  been  used  in  the  United  States  as  a  means 
of  meeting  fiscal  emergencies,  especially  those  springing  from  the 
extraordinary  expenditures  occasioned  by  wars.  The  expense  of 
sending  troops  to  the  Indian  wars  was  one  of  the  things  that  led 
most  of  the  American  colonies  to  issue  paper  money.  The  his- 
tory of  these  colonial  "  bills  of  credit,"  as  they  were  called,  illus- 
trates two  dangers  that  seem  to  be  inseparable  from  the  use  of  this 
financial  and  monetary  device.  In  the  first  place,  it  was  very 
easy  to  succumb  to  the  temptation  of  paying  ordinary  as  well  as 
extraordinary  expenditures  in  this  easy  way.  Some  of  the  colo- 
nies got  entirely  out  of  the  habit  of  taxing  themselves  to  meet 
current  public  expenses.  The  refusal  to  levy  taxes  was  a  prolific 
cause  of  disputes  between  colonial  assemblies  and  royal  gov- 
ernors. 

In  the  second  place,  because  no  money  was  raised  for  the  pur- 
pose, these  bills  of  credit  were  not  redeemed  promptly.  Their 
purchasing  power  fell  because  people  lost  confidence  in  their 
redeemability.  As  prices  rose  it  took  continually  larger  issues 
to  meet  the  government  expenditures,  and  each  increase  in  the 
amount  in  circulation  led  to  a  further  fall  in  purchasing  power. 
After  the  currency  had  become  practically  worthless,  it  was  a 
common  practice  to  repudiate  it  in  whole  or  in  part,  and  to  start 
afresh  with  bills  of  a  "  new  tenor."  Any  attempt  to  restrict 
this  reckless  use  of  public  credit  was  met  with  determined  resist- 
ance from  the  "  cheap  money  "  advocates  of  that  day.  There 
were  frequent  complaints  of  the  scarcity  of  money,  especially 
from  the  more  newly  settled  districts.  The  greater  the  quantity 
of  money  issued,  the  more  insistent  was  the  demand  for  still 
further  issues.  In  short,  this  colonial  experience  in  itself  gives 
sufficient  basis  for  the  inference  that  from  the  monetary  as  well 
as  the  fiscal  point  of  view,  the  use  of  paper  money  easily  de- 
generates into  a  bad  habit. 

Again,  in  the  Revolutionary  War,  paper-money  issues  were 
made,  —  this  time  by  the  Continental  Congress  as  well  as  by  the 
individual  colonies.  The  Continental  Congress  was  really 
driven  to  this  action  by  its  lack  of  the  power  of  levying  taxes. 


MONEY  273 

Its  bills  became  practically  worthless,  although  every  effort  was 
made  to  maintain  their  parity  with  metallic  money  by  appeals 
to  patriotic  sentiment.  After  the  formation  of  the  national 
government  a  few  of  them  were  redeemed  at  one  cent  on  the 
dollar. 

It  was  our  unfortunate  colonial  and  revolutionary  experience 
with  paper  money  which  led  to  the  insertion  of  the  wise  provision 
in  the  federal  Constitution  which  forbids  the  individual  states  to 
issue  bills  of  credit  or  to  make  anything  but  gold  and  silver  legal 
tender  in  payment  of  debts. 

The  Greenbacks.  —  The  federal  government  made  no  impor- 
tant issues  of  paper  money  until  the  Civil  War.1  It  was  not 
generally  foreseen  that  that  conflict  would  be  so  long  continued 
and  intense  as  it  was,  and  Congress  consequently  neglected  to 
make  adequate  provision  for  taxes  that  would  help  to  meet  the 
increased  expenditures  and  to  sustain  the  government  credit  in 
the  borrowing  operations  that  were  necessary.  In  1861  the 
Secretary  of  the  Treasury  was  authorized  to  issue  at  his  discre- 
tion $50,000,000  in  "  demand  notes,"  which,  although  they  were 
not  legal  tender,  could  be  used  in  all  payments  to  the  government. 
These  were  redeemed  promptly  on  demand  until  the  end  of  the 
year,  when  the  withdrawal  of  gold  from  the  banks  by  depositors 
for  hoarding,  and  by  the  government  for  its  own  uses,  led  first 
the  banks  and  then  the  government  to  suspend  specie  payments, 
—  that  is,  to  refuse  to  pay  their  current  obligations  in  gold. 

In  February,  1862,  moved  by  the  absolute  necessity  of  provid- 
ing some  kind  of  money  for  the  federal  treasury,  Congress 
authorized  the  issue  of  $150,000,000  in  legal  tender  notes,2  or 
greenbacks,  as  they  came  to  be  called.  It  was  hoped,  moreover, 
that  this  increase  in  the  circulating  medium  would  improve  the 
market  for  government  bonds  for  which  the  greenbacks  were  at 
first  made  convertible  at  par.    This  action  was  not  taken  without 


1  The  federal  government  issued  treasury  notes  in  the  war  of  1812  and  the  Mexi- 
can War,  and  during  the  panics  of  1837  and  1857.  Most  of  these  issues  were  interest 
bearing,  however;  in  no  case  were  they  legal  tender,  nor  did  they  get  into  common 
use  as  media  of  exchange. 

2  Including  the  "demand  notes,"  which  were  now  made  legal  tender. 


274  OUTLINES  OF  ECONOMICS 

strenuous  opposition  on  the  part  of  those  who  foresaw  some  of 
the  disastrous  consequences  of  large  paper  money  issues.  But 
as  in  earlier  American  experience  with  paper  money,  succeeding 
issues  met  with  less  and  less  resistance.  All  together,  green- 
backs to  the  amount  of  $450,000,000  were  issued  during  the  war. 

It  was  the  general  expectation  when  the  greenbacks  were  is- 
sued that  they  would  be  retired  as  soon  as  possible  after  the  con- 
clusion of  the  war.  But  when  such  action  became  possible,  it 
was  opposed  by  many  who  thought  that  the  reduction  of  the  cir- 
culating medium  would  decrease  prices,  impose  additional  bur- 
dens upon  debtors,  injure  business  interests,  reduce  the  public 
revenues,  and  hamper  the  government  in  the  refunding  of  its 
public  debt.  In  1866,  however,  Congress  authorized  the  gradual 
retirement  of  the  greenbacks,  but  repealed  the  act  in  1868.  The 
amount  in  circulation  in  1874  was  $382,000,000,  and  in  that  year 
a  bill  requiring  the  definite  increase  of  the  issue  to  $400,000,000 
was  prevented  from  becoming  law  and  thus  establishing  a 
dangerous  precedent  only  by  the  veto  of  President  Grant. 
Some  greenbacks  were  retired  under  the  provisions  of  an  act  of 
1875,  but  in  May,  1878,  there  were  $346,681,000  outstanding, 
and  as  a  law  then  enacted  provides  for  their  constant  reissue 
after  being  received  or  redeemed  at  the  treasury,  the  amount 
still  stands  at  that  figure.1  The  part  that  they  played  in  the 
financial  difficulties  of  1 890-1 893,  together  with  the  history  of  the 
treasury  notes  of  1890,  has  been  described  in  connection  with 
the  discussion  of  bimetallism. 

At  present  the  greenbacks  constitute  a  useful  and  acceptable 
part  of  the  stock  of  money.  But  if  another  financial  crisis  should 
deplete  the  government  treasury,  they  would  very  likely  prove 
again  to  be  a  source  of  difficulty.  Their  retirement  is  feasible 
under  present  conditions,  but  would  be  most  difficult  to  accom- 
plish under  the  very  financial  conditions  under  which  they  would 
be  most  dangerous.  The  currency  act  of  1900  provides  for  a 
gold  reserve  of  $150,000,000,  to  be  held  against  them  to  insure 
their  redeemability.  If  the  reserve  falls  below  $100,000,000, 
the  Secretary  of  the  Treasury  is  directed  to  replenish  it  from  the 
1  Since  igoo  they  have  been  reissued  only  in  exchange  for  gold. 


MONEY  275 

proceeds  of  bond  sales.  Although  this  gold  reserve  also  con- 
stitutes part  of  the  real  security  behind  our  silver  dollars,  it  could 
safely  be  diminished  in  amount  if  the  greenbacks  were  retired. 
Moreover,  if  a  great  national  emergency  should  ever  again 
make  the  issue  of  government  paper  money  necessary,  it  would 
be  highly  advantageous  to  have  the  greenbacks  out  of  the  way.. 

Economic  Effects  of  the  Greenbacks.  —  The  greenbacks  are  in 
form  promises  to  pay,  but  they  are  not  promises  to  pay  on  de- 
mand, nor  at  any  specific  time.  During  the  period  of  the  sus- 
pension of  specie  payments  they  were  not  actually  redeemable 
in  gold,  nor  was  gold  in  general  circulation  as  a  medium  of  ex- 
change except  on  the  Pacific  coast.  Gold  was,  however,  in  addi- 
tion to  its  industrial  uses,  employed  as  money  in  international 
trade,  in  the  payment  of  interest  on  government  bonds,  and  for 
customs  duties  (for  which  the  greenbacks  were  not  legally  re- 
ceivable). There  was  thus  a  constant  demand  for  gold  money, 
which  was  met  by  its  sale  as  a  commodity  in  the  New  York  mar- 
ket. The  gold  market  was  highly  speculative,  the  daily  and 
even  the  hourly  fluctuations  in  the  price  of  gold  in  greenbacks 
being  considerable.  Notwithstanding  these  speculative  features 
the  prices  paid  for  gold  indicated  very  accurately,  in  the  long  run, 
how  much,  in  the  expert  judgment  of  market  specialists,  the 
greenbacks  should  be  discounted  as  compared  with  gold. 

Everything  that  was  thought  to  affect  the  probability  of  the 
ultimate  redemption  of  the  greenbacks  in  gold  influenced  their 
price.  Among  these  factors  were  the  quantity  of  greenbacks 
issued,  the  condition  of  the  federal  treasury,  the  military  suc- 
cesses and  reverses  of  the  Union  cause,  and,  in  later  years,  the 
prospects  for  the  resumption  of  specie  payments.  Greenbacks 
reached  a  parity  with  gold  two  weeks  before  the  resumption  of 
specie  payments  on  January  1,  1879.  A  fact  of  special  signifi- 
cance is  that  until  July,  1863,  the  greenbacks  were  convertible 
at  par  into  6  per  cent  gold  t^nds.  These  bonds  formed  an  ac- 
tual standard  of  value  for  the  greenbacks,  and  although  them- 
selves depreciated,  exercised  for  the  time  being  a  steadying 
influence  upon  their  price. 

As  the  common  medium  of  exchange  consisted  almost  entirely 


276  OUTLINES  OF   ECONOMICS 

of  greenbacks  !  and  of  bank  notes  convertible  only  into  green- 
backs, prices  were  stated  in  greenback  "  dollars  "  and  naturally 
rose  as  the  gold  value  of  the  greenback  depreciated.  Reference 
to  the  table  on  the  next  page  will  show  a  rough  correspondence 
between  changes  in  the  general  level  of  prices,  expressed  in  green- 
backs, and  changes  in  the  price  of  gold,  also  expressed  in  green- 
backs. But  the  wholesale  prices  of  commodities  rose  relatively 
higher  than  did  the  price  of  gold,  and  declined  less  rapidly.2 
Retail  prices,  in  turn,  declined  less  rapidly  than  did  wholesale 
prices.  Wages  advanced  more  slowly  than  prices;  maximum 
wages  were  not  paid  until  1872,  —  seven  years  after  retail  prices 
and  eight  years  after  wholesale  prices  had  reached  their  maxi- 
mum. 

That  there  was  not  a  closer  correspondence  between  the  movement  in  gen- 
eral prices  and  the  changes  in  the  gold  value  of  the  greenback  was  due  to  two 
sets  of  influences :  (1)  Even  if  greenbacks  had  not  been  issued,  and  if  prices 
had  been  expressed  in  gold,  there  would  have  been  marked  fluctuations  in 
prices,  —  not  only  such  as  continually  occur  in  normal  years,  but  also  those 
due  to  such  exceptional  things  as  the  withdrawal  of  a  large  number  of  men 
from  industry  and  agriculture  to  military  service,  the  shifting  of  productive 
effort  in  response  to  the  enormous  demand  for  military  supplies,  the  period 
of  extraordinary  business  activity,  of  railway  building,  and  of  agricultural 
and  industrial  expansion  that  followed  the  war,  the  reaction  and  financial 
crisis  in  1873,  and  the  return  of  prosperous  conditions  in  the  last  years  of  the 
greenback  period.1  (2)  The  depreciation  in  the  gold  value  of  the  greenback 
was  recorded  quickly  and  accurately  in  the  gold  market,  but  the  movement 
of  prices  was  hampered  by  habit,  custom,  existing  contracts,  local  influences, 
etc.  Retail  prices  are  less  sensitive  to  changing  market  conditions  than  are 
wholesale  prices.     Wages,  in  turn,  are  usually  less  mobile  than  retail  prices. 

1  Subsidiary  coins  did  not  go  out  of  circulation  until  1862,  when  the  value  of 
the  greenback  dropped  below  the  value  of  the  bullion  in  these  coins.  Postage  stamps 
and  notes  and  tokens  issued  by  cities  and  by  business  firms  were  for  a  while  used 
as  small  change.  In  1862  the  situation  was  helped  by  the  issue  of  fractional  paper 
currency  in  denominations  as  low  as  three  cents. 

J  The  more  detailed  figures,  of  which  the  table  given  here  is  only  a  summary, 
show  that  the  prices  of  commodities  also  advanced  more  slowly  than  did  the  price 
of  gold.  For  an  illuminating  discussion  of  these  price  changes  see  Mitchell,  Gold, 
Prices,  and  Wages  under  the  Greenback  Standard,  Chap.  v. 

*This  statement  is  subject  to  the  limitation  implied  in  the  fact  that  general 
commercial  conditions  were  themselves  caused  in  part  by  the  influence  of  the  cheap 
and  fluctuating  medium  of  exchange. 


MONEY 


277 


TABLE   I 
Prices  and  Wages  in  the  Greenback  Period1 


Year 

Average 

Annual  Price 

of  Gold  in 

July 
Wholesale 

Average  Annual  Prices3 

Average 
Wages  * 

Greenbacks 

Prices  2 

Wholesale 

Retail 

i860 

— ■ 

100 

100 

IOO 

IOO 

1861 

— 

95 

94 

107 

99 

1862 

113-3 

120 

109 

131 

104 

1863 

145.2 

155 

148 

168 

119 

1864 

203.3 

236 

225 

215 

142 

1865 

157-3 

183 

224 

219 

X5S 

1866 

140.9 

191 

203 

208 

164 

1867 

138.2 

170 

177 

193 

167 

1868 

139-7 

165 

180 

190 

170 

1869 

I33-0 

158 

172 

177 

179 

1870 

114.9 

145 

156 

166 

179 

1871 

ill. 7 

137 

144 

J55 

184 

1872 

112.4 

J39 

138 

!5! 

185 

1873 

113.8 

140 

143 

148 

183 

1874 

III. 2 

138 

144 

*45 

175 

187S 

II4.9 

129 

134 

140 

163 

1876 

III.5 

118 

120 

i35 

153 

1877 

IO4.8 

114 

117 

i34 

143 

1878 

IOO.8 

99 

99 

127 

142 

1879 

100.0 

98 

93 

123 

*39 

All  these  things  interacted.  Wages,  to  give  only  one  example,  constitute  an 
important  part  of  the  expenses  of  producing  commodities,  and  the  sluggish 
movement  of  wages  kept  the  expenses  of  production  from  advancing,  and 
later  from  falling,  as  rapidly  as  would  otherwise  have  been  the  case,  and 
must  have  had  a  corresponding  effect  on  the  prices  charged  for  commodities. 

Aside  from  these  general  changes,  the  minor  fluctuations,  the 
short-time  variations  in  prices,  were  unusually  wide  and  numer- 

1  Compiled  from  Gold,  Prices,  and  Wages  under  the  Greenback  Standard,  by  Wesley 
C.  Mitchell.  The  figures  in  the  price  columns  are  obtained  by  counting  the  price 
of  each  commodity  in  each  year  as  a  percentage  of  its  price  in  i860,  and  then  averag- 
ing the  various  relative  prices  thus  obtained  for  each  year.  The  figures  in  the  wage 
column  are  computed  in  a  similar  way.  In  the  "price  of  gold"  column  parity  be- 
tween greenbacks  and  gold  is  represented  by  100. 

2  92  commodities.  3  21  commodities.  *  For  78  establishments. 


278  OUTLINES  OF   ECONOMICS 

ous,  —  a  fact  which  may  be  attributed  to  the  uncertain  future 
of  the  medium  of  exchange.  Such  fluctuations  were  apt  to  up- 
set all  business  calculations ;  chance  became  more  important  and 
foresight  less  important  as  a  factor  in  profits.  Under  such  condi- 
tions an  intense  and  reckless  spirit  of  speculation  was  bred,  with 
unfortunate  effects  on  business  morality  as  well  as  on  economic 
conditions. 

As  a  fiscal  expedient,  the  greenbacks  led  to  results  as  disastrous 
as  those  which  attended  their  use  as  money.  The  government 
was  forced  to  sell  bonds  for  depreciated  greenbacks,  but  in  order 
to  maintain  its  credit  it  had  to  pay  the  interest  and  ultimately 
the  principal  of  these  bonds  in  gold.  Supplies  for  the  army  were 
paid  for  in  depreciated  greenbacks,  but  these  greenbacks  had  to 
be  ultimately  redeemed  in  gold.  It  has  been  estimated  that 
the  use  of  the  greenbacks  increased  the  expense  of  the  Civil  War 
by  nearly  $600,000,000. * 

Fiat  Money.  —  After  1873  the  advocates  of  cheap  money  were 
not  content  with  merely  opposing  any  reduction  in  the  quantity 
of  the  greenbacks.  They  went  so  far  as  to  urge  that  the  amount 
of  paper  should  be  greatly  increased,  and  that  the  use  of  metallic 
money  should  be  definitely  and  permanently  abandoned.  Bank 
notes  were  also  attacked  because  they  were  issued  by  "  privileged 
corporations."  The  question  came  to  be  an  important  political 
issue,  and  in  1876  it  brought  about  the  organization  of  the  Green- 
back party,  which  figured  in  three  presidential  campaigns, 
and  which  polled  more  than  a  million  votes  in  the  congressional 
elections  of  1878.  In  more  recent  years  similar  demands  were 
voiced  by  the  Populist  party. 

The  theory  of  money  which  formed  the  basis  of  the  contention 
of  the  members  of  the  Greenback  party  is  sometimes  called  the 
"  fiat  money  "  theory.  Those  who  held  this  theory  of  money 
saw  no  significance  in  the  fact  that  the  greenbacks  were  in  form 
promises  to  pay  and  that  they  were  generally  regarded  as  only 

1  This  estimate  applies  only  to  the  increased  expense  to  Ike  government,  and  conse- 
quently to  its  taxpayers.  The  real  economic  cost3  of  the  war  were  not  greatly 
affected  by  the  use  of  the  greenbacks.  Bondholders  gained,  for  example,  a  large 
part  of  what  taxpayers  lost 


MONEY  279 

temporarily  irredeemable.  In  their  view  they  were  simply 
"  dollars,"  made  such  by  the  expressed  will  of  the  government. 
Nor  did  they  see  any  significance  in  the  fact  that  during  the 
seventeen  years  of  the  suspension  of  specie  payments  over 
$500,000,000  in  United  States  gold  6oins  issued  from  the  mints. 
As  a  matter  of  fact  the  fiat  money  advocates  were  misled  by  what 
some  logicians  have  called  the  "  jingle  fallacy."  That  the 
"  dollar  "  of  the  ordinary  medium  of  exchange  and  the  "  dollar  " 
as  a  standard  monetary  unit  were  different  things  did  not  occur 
to  them. 

If  they  had  succeeded  in  eliminating  the  credit  element  in  the 
paper  currency  by  ceasing  to  print  "  promises  to  pay  "(as  they 
actually  proposed  to  do),  and  had  instituted  a  new  name  for  the 
money  unit,  —  possibly  (to  reverse  the  spelling  )"  rallod,"  — 
they  would  perhaps  have  encountered  difficulty  in  getting  people 
to  use  pieces  of  printed  paper,  informing  them  that  "  This  is  a 
rallod"  as  money.  It  is  hard  to  see  how  "  the  supply  of  money 
as  compared  with  the  demand  for  it,"  on  which  the  fiat  money 
advocates  counted  to  fix  the  purchasing  power  of  their  money 
units,  would  have  helped  matters  very  much.  Nor  would  the 
redeemability  of  fiat  money  in  interest-bearing  bonds,  which  was 
suggested  by  some,  have  given  us  a  monetary  standard.  For  the 
bonds  would  have  been  merely  promises  to  pay  certain  sums  of 
fiat  money,  with  interest  at  a  certain  rate,  also  in  fiat  money. 
The  difficulties  that  would  have  been  encountered  in  international 
trade  would  alone  have  sufficed  to  make  fiat  money  impossible. 

This  should  not  be  taken  to  mean,  however,  that  irredeemable 
paper  money,  issued  in  familiar  denominations,  may  not  under 
favorable  circumstances  circulate  for  some  time  among  people 
accustomed  to. its  use,  even  if  there  is  no  prospect  of  its  ever 
being  redeemed.  The  most  important  of  the  necessary  "  favor- 
able circumstances  "  is  the  absence  of  complications  in  foreign 
trade,  such  as  have  already  been  discussed  in  connection  with 
the  subject  of  seigniorage.  But,  at  best,  there  would  be  a  host 
of  practical  difficulties  in  the  way  of  getting  the  right  amount 
of  money,  and  only  the  right  amount,  into  circulation. 


280  OUTLINES  OF   ECONOMICS 

QUESTIONS 

i.  Would  wheac  make  a  satisfactory  money  commodity?  iron?  plati- 
num ?   diamonds  ? 

2.  Would  it  be  possible  to  maintain  a  seigniorage  of  10  per  cent  on  United 
States  gold  coinage?  What  would  be  the  effect  on  the  prices  of  imported 
commodities?     of  domestic  commodities? 

3.  Report  on  the  following  questions  not  answered  in  this  chapter : 
(1)  What  is  the  "limit  of  tolerance"?  (2)  On  whom  does  the  loss  from  the 
wear  of  gold  coin  fall?  (3)  To  what  extent  are  different  kinds  of  United 
States  money  legal  tender  ? 

4.  If  the  United  States  had  adopted  the  free  and  unlimited  coinage  of 
silver  in  1896,  how  would  prices  have  been  affected? 

5.  Is  the  actual  monetary  standard  pure  gold  or  gold  of  standard  fineness  ? 

6.  What  elements  of  truth  are  there  in  the  statement  that  "coins  get 
their  value  from  the  government  stamp"? 

7.  In  the  table  printed  on  page  254,  why  are  not  gold  certificates,  silver 
certificates,  and  treasury  notes  of  1890  included  in  the  statement  of  the 
aggregate  amount  of  money  in  the  United  States? 

8.  Interpret  the  statement :  "The  value  of  the  greenbacks  depreciated." 
Explain  in  particular  the  meaning  of  the  words  value  and  depreciated  as  thus 
used. 

9.  Do  you  make  a  loan  to  the  government  when  you  receive  greenbacks 
in  payment  for  goods  or  services? 

REFERENCES 

Bullock,  C.  J.    Essays  in  the  Monetary  History  of  the  United  States. 
Commission  on  International  Exchange  (1904).     Report  on  the  Introduction 

of  the  Gold  Exchange  Standard. 
Dewey,  D.  R.    Financial  History  of  the  United  Stales.     (See  index.) 
Director  of  the  Mint.     Annual  Report. 

Dodd,  A.  F.     History  of  Money  in  Great  Britain  and  America. 
Hepburn,  A.  B.    History  of  American  Currency. 
Huntington,  A.  T.,  and  Mawhinney,  R.  J.  (Compilers).     Laws  of  the 

United  States  Concerning  Money,  Banking,  and  Loans,  1778-iQOQ. 
Jevons,  W.  S.    Money  and  the  Mechanism  of  Exchange.     • 
Johxson,  j.  F.     Money  and  Currency. 
Kinley,  David.     Money. 
Knox,  J.  J.     United  Stales  Notes. 
Laughlin,  J.L.    History  of  Bimetallism  in  the  United  States;  The  Principles 

of  Money. 
Mitchell,  W.  C.     History  of  the  Greenbacks;    Gold,  Prices,  and  Wages 

under  the  Greenback  Standard. 
Scott,  W.  A.     Money  and  Banking,  Chaps,  i-vi,  xiv,  xv. 


MONEY  281 

Taussig,  F.  W.     Principles  of  Economics,  Vol.  i,  Chaps,  xvii-xxiii. 

Treasurer  of  the  United  States.  Annual  Report.  (This,  together  with  ab- 
breviated forms  of  the  reports  of  the  Director  of  the  Mint  and  the 
Comptroller  of  the  Currency,  is  printed  as  an  appendix  to  the  Report 
of  the  Secretary  of  the  Treasury  in  the  bound  edition  of  the  annual 
Finance  Report.) 

Walker,  F.  A.    Money;  Money  in  its  Relation  to  Trade  and  Industry. 

Watson,  D.  K.    History  of  American  Coinage. 

White,  Horace.    Money  and  Banking. 


CHAPTER  XV 
CREDIT  AND   BANKING 

Credit  Transactions.  —  Thus  far,  in  our  discussion  ot  money, 
we  have  failed  to  take  account  of  the  fact  that  the  greater  part 
of  exchanges  are  credit  transactions,  which  do  not  directly  or 
immediately  involve  the  use  of  money  (in  the  sense  of  generally 
acceptable  money  instruments).  A  credit  transaction  is  a 
transfer  of  goods,  services,  or  money  for  a  future  equivalent. 
In  a  "  cash  "  transaction  there  are  only  two  elements,  —  the 
goods  sold  and  the  money  paid  for  them.  But  in  a  credit  trans- 
action a  third  .element  —  time  —  is  added.  The  introduction 
of  this  third  element  leads  to  exceedingly  important  results. 
In  the  first  place  it  makes  possible  an  enormous  number  of  ex- 
changes in  which  the  buyer  is  either  unable  or  disinclined  to  ren- 
der a  present  equivalent.  In  the  second  place  it  obviates,  to  a 
very  large  extent,  the  necessity  of  using  money. 

Suppose,  for  example,  that  A  and  B  are  the  only  inhabitants  of 
an  isolated  community.  Three  ways  of  making  exchanges  are 
open  to  them.  They  can  use  a  system  of  direct  exchange  or 
barter,  which  will  prevent  A  from  getting  goods  from  B  unless  he 
has  some  equivalent  which  he  is  willing  to  give  up  and  which  B 
is  willing  to  accept.  Or,  they  may  use  one  commodity  as  money, 
in  which  case  the  purchasing  power  of  either  A  or  B  at  any  given 
time  will  be  governed  by  the  amount  of  that  particular  commod- 
ity he  possesses,  rather  than  by  the  total  amount  of  all  his  posses- 
sions. But  by  combining  a  system  of  credit  with  their  use  of 
money,  they  will  be  able  to  make  transfers  freely,  for  in  an  occa- 
sional balancing  of  accounts  most  of  the  payments  due  each  other 
will  cancel,  leaving  only  a  relatively  small  amount  to  be  paid  in 
money. 

282 


CREDIT  AND   BANKING  283 

Something  very  much  like  this  third  process  is  continually 
going  on  in  contemporary  economic  life.  The  process  is  more 
complex,  however,  because  A  actually  sells  things  to  one  person 
or  group  of  persons,  and  buys  them  from  other  persons.  And  it 
is  very  likely  that  these  two  groups,  the  sellers  and  the  buyers 
in  A's  transactions,  have  no  direct  business  transactions  with 
each  other  in  which  their  respective  claims  against  A  and  debts 
to  A  can  be  canceled.  If,  however,  we  take  all  buyers  and  all 
sellers  into  account,  and  if  we  could  push  our  analysis  of  the  com- 
plex network  of  credit  relations  far  enough,  we  would  find  points 
of  contact  between  A's  credits  and  his  debts.  That  is,  if  A  gives 
a  promissory  note  in  exchange  for  a  purchased  good,  this  promis- 
sory note  might  be  passed  on  from  hand  to  hand  until  it  got  into 
the  possession  of  someone  who  is  indebted  to  A,  —  if  the  path  it 
should  take  were  known.  The  difficulty  is  that  the  path  is  not 
known.  The  institution  of  banking,  however,  provides  clearing 
centers,  where  credits  and  debts  are  balanced  against  each  other 
and  canceled. 

A,  for  example,  has  a  "  deposit  "  in  a  local  bank,  which  means 
that  he  has  the  right  to  demand  money  from  it  at  any  time  up  to 
the  amount  of  his  deposit.  He  usually  makes  a  payment  to  B, 
not  by  money  or  by  a  promissory  note,  but  by  a  check,  —  an 
instrument  ordering  the  bank  to  pay  B  the  specified  amount. 
This  check  will  be  presented  for  payment  by  B  at  a  bank  where  he 
has  a  deposit,  but  the  "payment "  will  usually  be  made  by  add- 
ing the  amount  of  the  check  to  B's  deposit.  If  it  is  the  bank 
where  A  also  has  his  deposit,  the  transaction  is  settled  by  the 
simple  process  of  debiting  A's  deposit  and  crediting  B's.  If 
it  is  another  bank  in  the  same  town,  and  if  the  town  is  a  small  one, 
the  check  will  enter  into  the  daily  exchange  by  the  two  banks 
of  such  claims  against  each  other,  the  daily  balance  in  favor  of 
either  bank  being  usually  settled  in  money. 

In  the  larger  cities  a  further  economy  in  the  use  of  money  is 
achieved  by  means  of  the  clearing  house,  to  which  a  representa- 
tive of  each  bank  brings  daily  all  of  the  checks  drawn  against 
other  local  banks  which  it  has  received  since  the  last "  clearing." 
At  the  clearing  house  the  checks  are  turned  over  to  the  repre- 


284  OUTLINES  OF   ECONOMICS 

sentatives  of  the  banks  against  which  they  are  drawn,  but  bal- 
ances are  not  settled  between  the  individual  banks.  Instead, 
a  balance  is  struck  between  the  total  sum  of  each  bank's  claims 
against  other  banks  and  the  total  claims  of  other  banks  against 
it.  Each  bank  then  pays  to  the  clearing  house,  usually  in  money, 
or  receives  from  it,  as  the  case  may  be,  the  amount  of  balance 
due  to  it  or  from  it.  This  system  achieves  a  great  economy  of 
both  time  and  money.1 

If  the  banks  in  which  A  and  B  keep  their  deposits  are  in  differ- 
ent towns,  A's  check  will  probably  be  sent  by  B's  bank  to  a  bank 
in  a  neighboring  large  city,  in  which  B's  bank  has  its  own  deposit 
account.  If  A's  bank  is  also  in  the  territory  tributary  to  this 
same  city,  the  check  may  be  sent  by  the  city  bank  directly  to 
A's  bank  for  collection,  or  to  its  own  correspondent  bank  in  the 
same  town.  If  A's  bank  is  in  another  part  of  the  country,  the 
check  will  be  sent  to  a  bank  located  in  a  large  city  in  that  region, 
which  will  attend  to  its  collection.2  Thus  a  check  drawn  on  a 
local  bank  in  California,  deposited  in  a  local  bank  in  Illinois,  will 
very  likely  be  collected  via  Chicago  and  San  Francisco.  The 
balances  of  credits  and  debits  which  are  thus  created  between 
city  and  country  banks  are  settled  to  a  very  large  extent  by 
means  of  crediting  and  debiting  deposit  accounts  in  city  banks, 
thus  obviating  by  that  much  the  necessity  for  frequent  shipments 


1  Over  $90,840,000,000  in  checks  and  drafts  passed  through  the  New  York  Clearing 
House  in  the  year  ending  September  30, 1915.  The  money  balances  paid  amounted 
to  $5,340,000,000,  or  less  than  6  per  cent  of  the  total  clearings.  The  average  cash 
payments  required  during  the  last  sixty-two  years  have  amounted  to  less  than  5  per 
cent  of  the  clearings.  In  times  of  financial  stringency  clearing  houses  sometimes 
permit  payment  of  balances  in  "clearing  house  loan  certificates,"  issued  to  individual 
banks  upon  the  basis  of  approved  securities  deposited  with  the  clearing  house.  In 
some  cases  the  banks  have  temporarily  put  such  certificates  into  general  circulation 
as  emergency  currency. 

*  The  London  Clearing  House  clears  for  all  England  in  a  very  simple  and  efficient 
way.  A  country  bank  sends  its  daily  receipts  of  checks  on  banks  in  other  towns 
to  the  London  bank  in  which  it  keeps  a  deposit.  In  a  daily  "country  clearing" 
these  checks  are  distributed  to  the  London  banks  where  the  banks  on  which  the 
checks  are  drawn  keep  accounts.  The  mere  territorial  extent  of  the  United  States 
makes  such  a  scheme  unworkable  here.  The  federal  reserve  banks,  however, 
hope  to  develop  a  system  of  regional  and  inter-regional  clearings  for  their  member 
banks. 


CREDIT   AND   BANKING  285 

of  money.  In  general,  we  have  in  the  United  States  a  continuous 
balancing  and  cancellation  of  debts  and  credits,  first,  in  each 
locality ;  second,  between  each  important  city  and  its  tributary 
territory,  and,  third,  between  the  different  important  cities. 
Much  the  same  process  is  characteristic  of  international  exchange, 
but  that  is  a  topic  which  will  be  treated  in  another  chapter. 

Personal  Credit.  —  If  a  man  does  not  hoard  money  on  the  one 
hand,  or  fail  to  pay  his  debts  on  the  other  hand,  his  expenditures 
(including  investments)  are  bound  to  be,  in  the  long  run,  approxi- 
mately equal  to  his  income.  But  for  a  business  man  a  continuous 
equality  of  income  a?nd  expenditure  is  impossible.  At  some 
times  his  deposit  account  will  be  built  up  more  rapidly  than  he 
checks  it  out ;  at  other  times  his  need  for  means  of  making  pay- 
ments will  outrun  his  receipts.  If,  for  example,  he  is  a  con- 
tractor, whose  expenses  of  production  are  fairly  constant,  but 
whose  product  is  paid  for  only  when  completed,  or  a  merchant, 
who  replenishes  his  stock  of  goods  twice  a  year  but  whose  sales 
are  distributed  throughout  the  year,  or  a  farmer  who  must  pay 
his  harvest  expenses  before  he  sells  his  crops,  he  may  find  it  nec- 
essary to  utilize  his  credit.  This  he  does  by  giving  to  others 
rights  to  demand  money  from  him  in  the  future.  Now,  the  extent 
to  which  he  can  utilize  his  personal  credit,  his  power  of  purchasing 
things  without  immediate  money  payment,  will  depend  to  some 
extent  on  his  personal  ability  and  integrity.  But,  nevertheless, 
the  fundamental  measure  of  his  credit  will  be  the  amount  of  his 
realizable  wealth.  This,  however,. may  consist  in  part  of  prop- 
erty that  is  not  "  for  sale,"  —  his  stock  of  consumption  goods 
and  his  income-yielding  land  or  capital,  and  in  part  of  things  that 
he  hopes  to  sell  in  the  normal  course  of  business. 

These  things  do  not  have  to  be  sacrificed  immediately  in  order 
to  acquire  the  present  means  of  payment.  To  meet  a  temporary 
need  they  may  be  made  the  basis  of  credit,  through  the  process 
of  hypothecation,  a  name  which  means  the  conditional  transfer 
of  property  rights.  The  hypothecation  may  be  definite  and 
formal,  as  when  a  mortgage  is  given  on  specific  items  of  property 
or  when  valuable  credit  instruments  of  various  sorts  (such  as 
government  or  corporation  bonds,  bills  of  lading,  warehouse 


286  OUTLINES  OF   ECONOMICS 

• 

receipts,  etc.)  are  put  into  the  actual  possession  of  the  creditor 
as  "  collateral  security  " ;  or  it  may  be  simply  implied,  as  in 
the  case  of  an  "  unsecured  "  personal  note,  for  practically  all  of 
the  property  of  a  borrower,  over  and  above  the  items  specifi- 
cally hypothecated  for  certain  debts  is,  in  legal  fact,  hypothe- 
cated for  his  remaining  debts.  It  is  important  to  note,  too,  that 
future  values,  rather  than  present  values,  constitute  the  basis  of 
present  credit.  The  lender's  interest  is  in  the  question  of  the 
adequacy  of  the  money  value  of  the  security  at  the  time  when 
payment  becomes  due.  Present  prices  being  equal,  a  borrower 
can  secure  a  larger  amount  of  credit  when  market  conditions  are 
improving  than  when  they  are  declining. 

A  man's  probable  future  income  and  the  probable  future 
money  value  of  his  property,  then,  constitute  the  real  measure 
and  foundation  of  his  personal  credit.  His  personal  credit, 
however,  is  of  limited  use  to  him  as  a  means  of  payment.  Some 
difficulties  in  the  way  of  using  personal  notes  as  media  of  ex- 
change have  already  been  suggested.1  There  is  another  diffi- 
culty in  the  fact  that  his  personal  notes  will  not  be  willingly 
accepted  by  others  in  lieu  of  money  payments  unless  they  know 
him,  the  value  of  his  property,  and  the  extent  to  which  it  is 
already  hypothecated.  Moreover,  these  same  difficulties  stand 
in  the  way  of  such  notes  being  passed  from  hand  to  hand,  even 
with  successive  indorsements. 

Bank  Credit.  —  In  order  to  acquire  a  readily  available  medium 
of  exchange,  personal  credit  has  to  be  exchanged  for  bank  credit. 

1  It  is  true,  of  course,  that  business  men  often  accept  their  customers'  notes  in 
payment  of  accounts,  or  as  an  equivalent  for  goods  purchased.  These  notes, 
however,  do  not  usually  pass  any  farther  as  a  medium  of  exchange,  but  are  in- 
dorsed by  the  business  man  and  presented  to  a  bank  for  discount.  Such  notes, 
often  known  as  "trade  paper,"  constitute  a  large  part  of  the  securities  of  many 
commercial  banks.  In  recent  years,  however,  an  increasing  proportion  of  banl 
loans  have  been  made  ipon  "one-name  paper."  Buyers  find  it  advantageous  tc 
secure  the  discounts  for  cash  payments  usually  given  by  manufacturers,  whole- 
salers, and  jobbers,  obtaining  the  necessary  funds  by  borrowing  from  the  banks 
on  their  own  notes.  The  federal  reserve  banks  are  attempting  to  increase  the  use 
of  pa  >er  bearing  the  names  of  both  buyer  and,  seller,  and  in  particular  to  develop 
a  larger  use  of  bills  of  exchange  (drafts)  in  place  of  promissory  notes.  The  pur- 
pose is  to  make  it  easier  to  distinguish  those  borrowings  which  arise  from  "  actual 
commercial  transactions." 


CREDIT  AND   BANKING  287 

Instead  of  using  his  own  note  as  a  medium  of  exchange,  a  business 
man  will  normally  have  it  "  discounted  '  by  his  banker.  If  the 
note  is  for  sixty  days,  for  example,  the  business  man  yields  the 
right  to  demand  a  specific  amount  of  money  from  him  in  sixty  days, 
in  exchange  for  a  deposit  credit,  —  the  right  to  receive  on  demand 
the  same  amount  of  money  less  the  discount}  The  business  man 
adds  the  note  to  his  liabilities  and  the  deposit  to  his  assets.  The 
bank  adds  the  note  to  its  assets  and  the  deposit  to  its  liabilities. 

Having  exchanged  his  personal  credit  for  a  bank  deposit,  the 
business  man  can  now  use  the  latter  as  a  means  of  payment 
through  the  checking  system  that  has  been  described.  Ordinary 
commercial  banking  consists,  in  large  part,  of  this  purchase  of 
personal  credit  and  sale  of  banking  credit.  The  bank  builds 
up  assets  in  the  form  of  loans  and  discounts  at  the  same  time  that 
it  builds  up  its  obligations  in  the  form  of  deposits. 

The  security  behind  the  deposit  liabilities  of  any  bank  consists 
of :  (1)  loans  and  discounts,  which  in  turn  rest  back  upon  per- 
sonal credit  or  upon  specifically  hypothecated  property  (as  in 
the  case  of  loans  on  collateral  security) ;  (2)  bonds,  mortgages, 
and  other  securities  owned  by  the  bank,  which,  if  necessary, 
may  be  sold  for  the  benefit  of  the  depositors,  unless  specifically 
pledged  as  security  for  bank  note  issues ;  (3)  the  bank's  own  de- 
posits in  other  banks,  together  with  the  checks  or  similar  claims 
against  other  banks  that  are  in  its  possession;  (4)  its  other 
property  (building,  fixtures,  etc.) ;  (5)  (in  national  banks  and 
some  state  banks)  the  personal  liability  of  the  bank's  stock- 
holders ; 2  (6)  its  stock  of  money. 

1  Discount  is  simply  one  form  of  interest.  Banker's  discount  differs  from  ordi- 
nary interest  in  that  it  is  computed  as  a  certain  per  cent  of  the  total  amount  that 
is  repaid,  while  ordinary  interest  is  computed  as  a  per  cent  of  the  amount  that  is 
lent.  Discount  is  deducted  from  the  principal  of  the  loan  in  advance;  interest 
is  paid  at  the  maturity  of  the  loan  or  (on  long  time  loans)  at  stated  intervals.  On 
demand  or  "call"  loans  and  on  time  loans  on  collateral  security  "interest"  rather 
than  "discount"  is  charged. 

2  Even  in  case  some  of  the  bank's  loans  or  securities  prove  worthless  there  is  a 
margin  of  safety  for  the  depositors  in  the  fact  that  some  of  the  assets  of  the  bank 
represent  the  original  investments  of  the  bank's  stockholders  {"capital")  or  profits 
which  they  have  put  back  into  the  business  ("surplus"),  and  on  such  assets  the 
depositors  have  the  first  claim.     Moreover,  in  national  banks  and  some  state  bank? 


288  OUTLINES  OF  ECONOMICS 

But  that  these  assets  should  suffice  to  cover  the  deposit  lia- 
bilities of  a  bank  is  not  in  itself  sufficient  to  maintain  its  solvency. 
Much  depends  upon  the  character  of  the  assets,  —  the  amount 
of  money  included  in  them,  and  the  ease  and  quickness  with 
which  other  parts  of  the  assets  can  be  converted  into  money. 
Each  deposit  account  is  an  obligation  of  the  bank  to  pay  in 
actual  money  if  it  is  demanded.  The  depositor  cannot  use 
checks  for  all  kinds  of  payments,  but  will  often  have  to  draw  on 
his  deposit  account  for  money.  Even  when  payments  are 
made  by  checks,  those  who  receive  them  will  often  prefer  to  cash 
them  rather  than  to  deposit  them.  Moreover,  the  process  of  the 
cancellation  of  credit  obligations  is,  as  we  have  seen,  not  alto- 
gether perfect.  Balances  arise  between  individual  banks  in  the 
same  city,  between  city  and  country,  between  different  cities, 
and  between  different  nations  that  very  often  have  to  be  settled 
in  money. 

Statement  of  the  Condition  of  a  National  Bank  in  a  Small  Town 


Resources 

Liabilities 

Building  and  fixtures  .     .      $45,000 
Government  bonds      .     .         50,000 
Other  securities ....         30,000 
Loans  and  discounts   .     .       460,000 
Due  from  other  banks      .         42,000 

Capital  stock   ....       $  50,000 

Notes  outstanding     .     .         48,000 

Due  to  other  banks  .     .           3,000 
Undivided  profits .     .     .           5, 000 

Total  resources   .     .     .    $662,000 

Total  liabilities      .     .     $662,000 

A  bank  accordingly  has  to  keep  enough  actual  cash  on  hand  to 
enable  it  to  meet  any  demands  that  may  be  made  upon  it  for 
money.  As  deposits  constitute  the  most  important  cash  obliga- 
tions of  most  banks,  the  size  of  this  money  reserve,  as  it  is  called, 
is  normally  fixed  for  safety's  sake  at  a  certain  per  cent  of  the 
amount  of  the  deposits.    This  proportion  varies  according  to 

the  stockholders  are  in  addition  personally  liable  up  to  an  amount  equal  to  the 
par  value  of  their  holdings. 


CREDIT  AND    BANKING  289 

the  location  of  a  bank  and  the  nature  of  its  business.  In  prac- 
tice it  varies  in  different  commercial  banks  from  as  low  as  5  per 
cent  to  as  high  as  35  per  cent  of  the  deposits. 

If  its  reserve  increases,  a  bank  is  at  liberty  to  increase  its  de- 
posits by  extending  its  loans  and  discounts,  attracting  these, 
possibly,  by  lowering  the  discount  rate.  If  the  reserve  is  de- 
creasing, the  bank  must,  for  safety,  contract  its  deposits  by  re- 
stricting its  loans  and  discounts,  or  by  taking  measures  (such  as 
the  sale  of  securities  for  money)  that  will  replenish  the  reserve.1 
In  order  that  the  ratio  of  reserve  to  deposits  may  be  maintained 
near  the  point  where  the  right  balance  is  struck  between  profit- 
ableness on  the  one  hand  and  safety  on  the  other  hand,  it  is  nec- 
essary that  the  bank's  assets  should  be  as  fluid  as  possible.  This 
is  best  accomplished  by  confining  most  of  the  loans  or  discounts 
to  notes  or  bills  of  exchange  that  are  payable  in  thirty,  sixty,  or 
ninety  days,  or,  at  most,  in  four  or  six  months,  so  that  a  constant 
flow  of  maturing  obligations  makes  it  possible  for  a  bank  to  ex- 
pand or  contract  its  loans  and  discounts,  and  hence  its  deposits, 
as  seems  most  advisable. 

There  has  been  in  the  larger  cities  of  the  United  States,  es- 
pecially in  New  York,  a  growing  use  of  bank  loans  payable  on 
demand.  This  enables  the  banks  to  keep  their  outstanding 
loans  much  closer  to  the  maximum  allowed  by  the  state  of  their 
reserves  than  would  otherwise  be  the  case,  but  the  practice  has, 
as  we  shall  see  presently,  other  effects  that  are  not  so  desirable. 

By  the  "  money  market  "  is  usually  meant  the  market  for 
freely  exchangeable  rights  to  receive  money  on  demand ;  that  is, 
in  reality,  the  bank  credit  market.  The  amount  of  bank  credit 
available,  the  freedom  with  which  banks  will  make  loans  on  cer- 
tain kinds  of  securities,  and  the  interest  and  discount  rates 
charged  for  bank  credit  are  among  the  things  that  make  up  what 
is  called  "  the  state  of  the  money  market."  But  it  should  be 
clear  to  the  reader  that  the  state  of  the  money  market  depends, 

1  Some  banks  maintain  a  "bond  reserve"  of  high  grade  securities  that  may  be 
sold  to  enable  the  bank  to  meet  an  extraordinary  demand  for  money  or  to  enable 
it  to  extend  its  loans  and  discounts  when  necessary.  Such  investments  are  nor- 
mally made  by  commercial  banks  when  the  demand  for  loans  does  not  absorb  the 
funds  at  the  bank's  disposal,  that  is,  when  money  reserves  are  unprofitably  large. 


290  OUTLINES  OF   ECONOMICS 

primarily,  on  two  things :  first,  the  amount  and  nature  of  the  per- 
sonal credit  that  can  be  exchanged  for  bank  credit,  and  second,  the 
amount  of  money  in  the  bank  reserves. 

Bank  Notes.  —  There  is  one  way,  however,  in  which  banks  can 
meet  some  of  the  demand  for  money  without  drawing  on  their  re- 
serves and  thus  reducing  their  power  of  extending  credit.  This 
is  by  the  issue  of  bank  notes,  which  are  simply  the  promises  of 
banks  to  pay  money  on  demand,  issued  in  convenient  and  famil- 
iar form  for  use  as  paper  money.  These  notes  are  paid  as  money 
to  customers  of  a  bank  who  want  the  proceeds  of  their  borrowings 
in  cash,  and  to  depositors  and  to  holders  of  checks  who  prefer 
money  to  deposit  credit.  Bank  notes  pass  readily  from 'hand 
to  hand  as  money,  and  at  the  present  time  constitute  an  impor- 
tant part  of  the  circulating  medium  in  most  countries. 

Bank  notes  are  like  deposits  in  that  both  are  demand  liabilities 
of  banks.  Bank  notes,  however,  circulate  among  persons  who 
have  no  means  of  informing  themselves  as  to  the  solvency  of  the 
banks  issuing  them.  The  holders  of  bank  notes  are  accordingly 
usually  given  special  protection  by  laws  which  regulate  the  con- 
ditions of  their  issue  and  redemption. 

State  Banks  of  Issue.  —  Before  the  Civil  War  the  actual  circu- 
lating medium  of  the  United  States  consisted  in  very  large  part  of 
notes  issued  by  banks  operating  under  state  laws.  The  notes 
issued  by  some  of  these  banks  were  as  "  good  as  gold  "  because 
the  banks  redeemed  them  promptly  in  gold,  —  a  fact  which  was 
due  in  some  cases  to  wise  and  rigid  state  regulation  of  banking, 
and  in  other  cases,  fewer  in  number,  to  conservative  use  of  the 
too  extensive  privileges  granted  by  lax  state  laws.  But  the  notes 
of  other  banks  were  depreciated  and  in  many  cases  were  abso- 
lutely worthless. 

Public  ignorance  of  the  real  nature  of  banking  gave  rise  to  the 
supposition  that  wealth  could  be  mysteriously  manufactured  by 
means  of  a  bank  charter  and  a  printing  press  (the  fiat  money 
theory  applied  to  bank  notes).  This  and  the  ever  recurring  de- 
mand for  cheap  money  were  responsible  for  the  situation.  Pro- 
hibited by  the  Constitution  from  issuing  their  own  bills  of  credit, 
many  of  the  states,  especially  in  the  South  and  West,  responded 


CREDIT   AND    BANKING  29 1 

to  the  clamor  for  cheap  money  by  making  it  possible  for  their 
citizens  to  organize  "  banks  "  and  issue  their  own  bills  of  credit, 
imposing  few  or  no  requirements  as  to  the  actual  investment  of 
capital,  the  accumulation  of  assets,  or  the  restriction  of  note  issue.1 
In  the  panics  of  1814,  1837,  and  1857  but  few  banks  maintained 
specie  payments.  Even  so  late  as  i860,  although  the  hard 
lessons  of  experience  had  brought  some  improvements,  especially 
in  the  older  states,  the  bank  note  circulation  was  of  decidedly 
varying  quality.  "  Bank  note  reporters  "  and  "  counterfeit 
detectors  "  had  to  be  issued  periodically  in  order  to  give  to  busi- 
ness men  the  latest  quotations  and  information  relating  to  the 
depreciated  currency  they  had  to  receive  in  the  ordinary  course 
of  business.  After  1861  the  suspension  of  specie  payments  led 
to  a  general  depreciation  of  bank  notes  as  compared  with  gold, 
because  most  of  them  were  thereafter  redeemable  only  in  green- 
backs. 

The  National  Banking  System.  —  The  successful  state  bank- 
ing system  of  New  York  was  the  model  after  which  Congress, 
following  the  recommendations  of  Secretary  Chase,  patterned 
the  national  banking  system  which  it  established  in  1863.  The 
primary,  although  not  the  only,  motive  that  led  to  this  action 
was  the  desire  to  provide  an  artificial  market  for  government 
bonds,  which  at  the  time  were  a  drug  on  the  market.  National 
banks  were  required  to  use  government  bonds  as  the  assets  be- 
hind note  issues,  and  furthermore,  the  national  banks  were, 
in  1866,  given  a  monopoly  of  the  note  issue  privilege  by  the  im- 
position of  a  prohibitive  tax  of  10  per  cent  per  annum  upon  the 
note  issues  of  state  banks. 

The  details  of  the  national  banking  law  have  been  amended 
from  time  to  time,  but  the  general  principles  of  the  regulation 
of  the  note  issue  remained  unchanged  until  Congress  passed  the 
Aldrich  Act  in  1908.  As  the  law  has  stood  since  1900,  national 
banks  may  not  be  organized  unless  the  stockholders  contribute 
a  minimum  capital,  varying  from  $25,000  for  places  of  less  than 

1  Some  states  circumvented  the  constitutional  prohibition  mentioned  by  estab- 
lishing their  own  banks  for  the  manufacture  of  paper  money.  The  Bank  of  Ken- 
tucky was  the  most  famous  of  these. 


292  OUTLINES  OF   ECONOMICS 

3000  population  to  $200,000  for  places  of  more  than  50,000  popu- 
lation. Three  limitations  are  put  on  the  ordinary  issue  of  cir- 
culating notes :  (1)  They  must  not  exceed  in  amount  the  capital 
stock  of  the  bank.  (2)  United  States  government  bonds  have 
to  be  purchased  by  the  bank  in  amount  sufficient  to  equal,  dollar 
for  dollar,  the  quantity  of  the  notes  issued,  and  these  bonds  have 
to  be  deposited  with  the  treasurer  of  the  United  States  as  secur- 
ity for  the  redemption  of  the  notes.  (3)  Each  bank  must  main- 
tain in  the  United  States  treasury  a  redemption  fund  in  "  lawful 
money  "  equal  to  5  per  cent  of  its  note  issue.  As  this  last  re- 
quirement indicates,  bank  notes  are  redeemable  at  the  federal 
treasury.  They  may  also  be  used  in  all  payments  to  the  govern- 
ment except  customs  duties,  although  they  are  not  legal  tender. 

The  Reserve  System.  —  While  the  note  holder  is  thus  pro- 
tected by  a  special  kind  of  security  set  aside  for  the  purpose,  the 
depositor  in  a  national  bank  is  protected  only  by  its  general 
assets.  These,  however,  are  regulated  to  some  extent  by  the 
federal  government.  There  are  restrictions,  for  example,  in- 
tended to  prevent  the  bank  from  tying  up  its  funds  in  long-time 
investments,  from  lending  too  much  to  one  person  or  firm,  or  to 
directors  or  officers  of  the  banks.  Five  times  a  year  national 
banks  have  to  furnish  full  statements  of  their  condition  to  the 
comptroller  of  the  currency  at  Washington.  Each  bank  is  also 
examined  twice  a  year,  without  notice,  by  federal  bank  examiners. 

But  the  most  important  requirement  relates  to  the  money  re- 
serves that  must  be  held  by  national  banks.  Until  the  Federal 
Reserve  Act  was  passed  in  191 3,  banks  in  "  central  reserve 
cities  "  (New  York,  Chicago,  and  St.  Louis)  were  required  to 
maintain  a  "  lawful  money  reserve  " x  equal  to  at  least  25  per 
cent  of  their  deposits.  Banks  in  other  "  reserve  cities  "  (in- 
cluding at  present  about  fifty  cities)  were  also  required  to  main- 
tain 25  per  cent  reserves,  but  their  deposits  in  the  national  banks 
of  the  central  reserve  cities  might  be  counted  for  one  half  of  this 
amount.  In  all  other  places  the  banks  were  required  to  hold 
a  15  per  cent  reserve,  three  fifths  of  which  might  consist  of  de- 
posit accounts  in  banks  in  central  reserve  cities  or  other  reserve 

1  Including  all  kinds  of  United  States  money  except  minor  coins  and  bank  notes. 


CREDIT  AND   BANKING 


293 


cities.  In  all  cases  the  funds  kept  by  the  banks  with  the  United 
States  treasurer  for  the  redemption  of  their  notes  were  counted 
as  part  of  their  legal  reserves. 

The  New  York  Money  Market.  —  Under  the  operations  of  this 
system  the  cash  reserves  of  the  national  banks  were  centered 
in  New  York.  This  appears  clearly  in  Table  I,  which  shows  that 
on  the  date  specified  (which  may  be  taken  as  fairly  representa- 
tive of  conditions  in  recent  years)  more  than  a  third  of  the  cash 
reserves  of  the  6544  national  banks  in  the  United  States  were  in 

TABLE   I 

Deposits  and  Reserves  of  National  Banks:  August  22,  1907 1 


No.  of 
Banks 

Deposits  2 

Reservk 

Classification  of  Reserve 

Location 

c 

3 
O 

1 

.2 

(2 

Lawful 

money  in 

bank2 

Due  from 
reserve 
agents s 

l! 

*3 

New  York     .     .     . 
Chicago    .... 
St.  Louis  .... 
Other  reserve  cities 
Country  banks  .     . 

38 

14 

8 

306 

6178 

825.7 

262.9 

116.8 

1423.4 

2627.2 

221.3 

66.6 

27.6 

362.3 

443-5 

26.8 

25-3 
23.6 

25-5 
16.9 

218.8 

66.1 

26.8 

190.3 

199.6 

165.7 
226.7 

2.6 

0.5 
0.7 

6-3 
17.2 

Total    .... 

6S44 

5256.1 

1 1 21.4 

21.3 

701.6 

392.4 

27-3 

the  vaults  of  thirty-eight  New  York  banks.4  These  figures  do 
not,  however,  convey  an  adequate  idea  of  the  national  impor- 
tance of  the  New  York  bank  reserves.  New  York  is  the  great 
wholesale  market  for  foreign  exchange,  the  chief  center  of  gold 
movements  to  and  from  Europe,  the  principal  importing  and 
exporting  center  for  commodities,  —  in  short,  the  chief  market 
place  of  the  continent  and  the  focus  of  financial  operations.  All 
state  banks,  private  banks,  and  trust  companies  of  importance 
find  it  to  their  advantage  to  maintain  deposit  accounts  in  New 

1  Compiled  from  Report  of  the  Comptroller  of  the  Currency,  1907,  pp.  222-224. 

2  Millions  of  dollars.  3  Per  cent. 

4  The  bulk  of  the  deposits  of  out  of  town  banks  was  in  from  twelve  to  twenty 
banks  which  have  made  a  specialty  of  this  kind  of  business. 


294  OUTLINES  OF  ECONOMICS 

York,  both  for  their  own  use,  and  in  order  that  they  may  supply 
New  York  exchange  to  their  customers.  Even  the  deposit  ac- 
counts of  national  banks  in  New  York  were  in  the  aggregate 
considerably  larger  than  the  amount  they  were  allowed  to  count 
as  part  of  their  reserves. 

All  together  the  deposits  of  other  banks  have  usually  consti- 
tuted more  than  half  of  the  aggregate  deposits  in  New  York 
national  banks.  Moreover,  something  very  much  like  this  re- 
serve system  existed  (and  still  exists)  among  other  than  na- 
tional banks,  the  banks  in  smaller  places  keeping  deposits  in 
national  or  other  banks  in  larger  cities,  which  in  turn  keep  de- 
posits in  New  York.  The  trust  companies,  and  some  of  the 
state  banks,1  keep  in  general  very  much  smaller  reserves  in  their 
own  vaults  than  are  required  of  national  banks,  —  a  fact  which 
made  the  strain  on  the  New  York  bank  reserves  all  the  greater. 

Like  an  inverted  pyramid  upon  its  apex,  the  great  structure  of 
bank  credit  in  the  United  States  has  rested,  in  large  measure, 
upon  the  money  reserves  of  the  New  York  banks.  Every  im- 
portant change  in  the  demand  for  money  or  credit  in  any  part 
of  the  country  has  had  an  effect  on  the  New  York  money  market ; 
similarly,  every  important  disturbance  in  the  New  York  money 
market  has  affected  financial  conditions  throughout  the  country. 

The  central  reserve  system  effects  a  great  economy  in  the  use 
of  money,  and,  what  is  more  important,  it  mobilizes  the  cash 
resources  of  the  country  in  such  a  way  that  variations  in  the  local 
supply  of  bank  credit  in  different  regions  resulting  from  differ- 
ences in  the  local  supply  of  money  available  for  bank  reserves 
are  minimized.  It  seems  to  be  a  natural  and  necessary  feature 
of  modern  banking,  for  something  like  it  is  found  in  all  the  lead- 
ing commercial  nations.  But  in  the  United  States  the  central 
reserve  system  has  worked  badly.  This  has  been  attributable 
in  part  to  other  defects  in  our  national  banking  laws  and  in  part 
to  some  unfortunate  features  of  the  reserve  system  itself.  Specifi- 
cally, the  principal  sources  of  difficulty  have  been  the  following  : 

1  Savings  banks  keep  reserves  that  average  for  the  United  States  only  four  fifths 
of  one  per  cent  of  their  deposits.  On  account  of  the  nature  of  their  business,  which 
is  not  banking  in  the  commercial  sense,  they  are  a  negligible  factor  in  this  connection. 


CREDIT  AND    BANKING  295 

(1)  the  dominance  of  speculative  influences  in  the  New  York 
money  market ;  (2)  the  independent  treasury  system ;  (3)  the 
lack  of  elasticity  in  our  bank  note  issues  ;  (4)  the  rigidity  of  our 
legal  reserve  requirements ;  (5)  the  absence  of  any  one  central 
authority,  responsible  for  the  custody  and  maintenance  of  the 
central  reserves.  We  now  proceed  to  the  discussion  of  these 
matters. 

Speculation  and  the  New  York  Money  Market.  —  As  Table  II 
shows,  a  large  proportion  of  the  loans  of  New  York  banks  have 
not  been  based  on  "  commercial  paper  " ;  that  is,  on  the  notes 
and  bills  of  exchange  that  arise  in  the  ordinary  course  of  business, 
but  have  been  either  time  loans  on  collateral  security  or  demand 
loans,  nearly  all  of  which  are  secured  by  collateral.  Most  of 
these  collateral  securities  are  the  stocks  and  bonds  of  corpora- 

TABLE  II 

Loans  and  Discounts  of  New  York  National  Banks  on  Specified 

Dates  1 
(In  millions  of  dollars) 


Character  of  Loan 

1890 

1901 

1906 

1912 

102 

43 

152 

279 
129 
203 

303 
149 
249 

344 
223 
39i 

On  time,  with  collateral  security 

On  time,  without  collateral  security 

cions,  and  the  loans,  especially  the  demand  or  "  call  "  loans,  are 
used  for  the  greater  part  in  financing  speculation  in  such  securi- 
ties. This  system  has  been  partly  responsible  for  the  excessive 
and  useless  expansion  of  speculation  over  and  above  the  amount 
that  is  necessary  to  secure  the  best  results  for  the  economic  in- 
terests of  the  country.  Here  we  are  concerned,  however,  with 
its  effects  on  the  money  market. 

The  supply  of  call  loans  depends  primarily  on  the  amount  of 
the  surplus  reserves  of  New  York  banks ;  that  is,  the  excess  of 
the  reserves  over  and  above  the  legal  minimum  percentage  of 

1  Compiled  from  Reports  of  the  Comptroller  of  the  Currency. 


296  OUTLINES  OF   ECONOMICS 

the  amount  of  their  deposits.  If  the  weekly  statement  of  the 
clearing  house  banks  shows  a  relatively  large  surplus  reserve, 
this  means  that  the  banks  can  safely  expand  their  loans,  and  the 
knowledge  of  this  fact  has  a  stimulating  effect  on  speculation. 
If,  however,  the  surplus  reserve  is  low,  the  banks  are  bound  to 
restrict  their  loans  of  all  kinds  and  to  "  call  "  some  of  their  de- 
mand loans.  When  the  reserve  is  below  the  legal  limit,  demand 
loans  have  to  be  called  in  large  quantities  in  order  to  enable 
the  banks  to  meet  pressing  demands  for  credit  on  the  part  of 
their  regular  customers.  The  precipitate  calling  of  demand 
loans  by  some  banks  simply  increases  the  demand  for  credit  at 
other  banks,  which  in  turn  have  to  curtail  their  loans.  Such  a 
condition  of  the  money  market  leads  to  a  depression  in  the  price 
of  speculative  securities,  which  is  increased  by  the  forced  sales 
of  securities  in  order  to  obtain  the  money  funds  that  had  pre- 
viously been  lent  on  them ;  the  fall  in  the  prices  of  securities 
leads  brokers  to  demand  more  "  margins  "  from  the  customers 
for  whom  they  have  bought  securities,  and  it  leads  the  banks  to 
demand  more  securities  as  collateral  for  their  outstanding  loans. 
Under  such  conditions  the  interest  rate  on  call  loans  has  some- 
times gone  as  high  as  125  per  cent,  or  even  higher.1 

If  the  ruling  prices  of  speculative  securities  have  been  higher 
than  industrial  conditions  would  warrant,  such  a  disturbance 
of  the  money  market  is  apt  to  be  long  continued,  and  might 
easily  develop  into  a  general  financial  crisis.  The  call  loan 
market  is  essentially  speculative,  and  it  is  unfortunate  that  the 
condition  of  the  supply  of  credit  for  the  normal  commercial  needs 
of  the  country  should  have  been  periodically  unsettled  on  ac- 
count of  this  fact.     In  no  other  great  money  center  of  the  world 

1  That  is,  the  rate  on  what  may  be  called  marginal  call  loans,  effected  at  the 
stock  exchange  by  bankers'  agents,  or  by  individuals  or  corporations.  Many 
banks  continue  to  make  call  loans  to  their  regular  customers  at  such  times  at  rates 
not  exceeding  6  per  cent.  Under  normal  conditions  the  rate  on  call  loans  is  lower 
than  the  rate  on  time  loans.  For  the  period  iooi-ioc6  the  bank  rate  on  call  loans 
averaged  3.3  per  cent  as  against  an  average  rate  of  about  4.5.  per  cent  on  time 
loans.  Excessive  variability  is  the  chief  characteristic  of  the  call  loan  rate.  Cf. 
W.  A.  Scott,  "Rates  on  the  New  York  Money  Market,"  Journal  of  Political  Econ- 
omy, vol.  xvi,  pp.  273-298. 


CREDIT  AND   BANKING  297 

do  call  loans  occupy  the  important  place  that  they  do  in  New 
York. 

The  Independent  Treasury  System.  —  The  United  States 
government  has  for  many  years  been  to  a  very  large  extent  its 
own  banker.  It  has  kept  its  own  money  in  its  own  strong  boxes, 
quite  after  the  fashion  of  a  medieval  monarch.  The  strong 
boxes  in  this  case  have  been,  however,  the  vaults  of  the  treasury 
in  Washington  and  of  nine  subtreasuries  located  in  important 
cities.  Apart  from  the  fact  that  the  government  revenue  and 
the  government  expenditures  are  naturally  not  distributed 
evenly  throughout  the  year,  the  government  has  the  further 
difficulty  that  a  close  balance  of  revenues  and  expenditures  for 
any  given  year  must  be  wholly  accidental.  Even  if  the  federal 
budget  were  carefully  and  scientifically  constructed,  as  it  is  not, 
the  public  revenues  would  be  liable  to  uncertain  fluctuations,  — 
a  result  in  part  of  the  importance  of  customs  receipts  among 
them.  The  government,  furthermore,  receives  a  large  part  of 
its  income  in  money,  not  in  bank  credit  instruments.  When  a 
surplus  accumulates  in  the  government  treasury,  that  much 
money  is  taken  out  of  circulation.  This  reduces  bank  reserves, 
and  contracts  the  amount  of  bank  credit  available.  And  it 
usually  happens  that  the  government  revenues  are  largest  when 
business  is  most  prosperous,  and  when,  consequently,  maximum 
bank  reserves  are  needed. 

The  government  is  permitted,  however,  by  the  national  bank 
act  of  1863  to  deposit  money  in  selected  national  banks.  Some 
secretaries  of  the  treasury  have  made  little  use  of  this  privilege, 
but  in  recent  years  such  deposits  have  become  more  common. 

Until  1902  banks  had  always  been  required  to  deposit  government  bonds 
with  the  federal  treasury  as  security  for  federal  deposits,  but  in  that  year 
and  again  in  1906  Secretary  Shaw  offered  to  accept  approved  state  and 
municipal  bonds  in  lieu  of  a  certain  amount  of  government  bonds,  on  condi- 
tion that  the  latter  should  be  immediately  used  as  security  for  increased 
note  issues.  Subsequently  the  banks  have  also  been  permitted  to  use 
"prime  commercial  paper,"  endorsed  by  the  banks,  as  collateral.  In  1897 
only  168  banks  were  government  depositories.  In  1914  there  were  1584, 
which  held  on  June  30  of  that  year  about  half  of  the  $170,000,000  constitut- 
ing the  government's  cash  surplus  at  that  date.     Part  of  this  increase  is 


298  OUTLINES  OF  ECONOMICS 

attributable  to  the  effect  of  a  law  enacted  in  1907  allowing  customs  receipts 
to  be  deposited  in  banks.  Prior  to  this  deposits  could  only  be  made  from  the 
proceeds  of  internal  revenue  duties  and  miscellaneous  receipts.  In  recent 
years  the  banks  have  been  required  to  pay  2  per  cent  interest  on  govern- 
ment deposits. 

The  government  has,  on  several  occasions,  come  to  the  rescue  of  the  banks 
by  cash  purchases  of  its  own  bonds.  The  decline  in  the  market  price 
of  government  bonds  in  periods  of  financial  stringency  makes  the  purchases 
relatively  advantageous  to  the  government.  The  periodic  shifting  of  govern- 
ment deposits  to  localities  where  money  is  most  needed,  the  temporary  de- 
posit of  gold  in  New  York  banks  equal  in  amount  to  their  engagements 
of  gold  for  transportation  from  Europe,  and  even  the  arbitrary  withdrawal 
of  government  money  from  the  banks  when  it  was  "not  needed,"  in  order 
that  it  might  not  be  made  the  basis  of  speculative  activities  but  kept  until 
it  "was  needed,"  have  been  notable  features  of  the  recent  relations  of  the 
treasury  and  the  money  market. 

In  favor  of  this  system  it  may  be  said  that  a  surplus  in  the  government 
treasury  constitutes  a  real  cash  reserve,  the  wise  use  of  which  by  the  Secre- 
tary of  the  Treasury  might  avert  a  serious  crisis.  But  there  are  dangers  in 
intrusting  so  much  financial  power  to  one  man.  If  used  without  discretion 
it  is  bound  to  do  more  harm  than  good.  Moreover,  these  treasury  operations 
have  not  always  been  free  from  the  suspicion  of  favoritism  to  certain  banks. 
Then,  too,  the  knowledge  that  the  government  surplus  will,  in  time  of 
necessity,  be  put  at  their  disposal  tends  to  encourage  unsound  banking  by 
relieving  the  banks  of  the  proper  responsibility  for  the  maintenance  of 
their  own  reserves. 

Finally,  it  should  be  noted,  the  use  of  the  independent  treasury  system 
has  prevented  the  government  from  securing  for  itself  any  large  measure 
of  the  various  economies  and  advantages  that  business  firms  find  in  keep- 
ing bank  accounts. 

The  Movement  of  Money.  —  The  demand  for  loanable  funds 
(rights  to  receive  money-  on  demand)  varies  locally,  according 
to  the  business  conditions  that  exist  in  different  parts  of  the 
country.  These  differences  make  loans  worth  more  in  some  lo- 
calities than  in  others,  and  result  in  some  shifting  of  bank  credit. 
New  York  banks,  for  example,  sometimes  invest  in  "  out  of 
town  "  commercial  paper  when  this  is  more  profitable  than 
employing  their  funds  at  home.  More  frequently,  interior 
banks  place  loans  in  New  York,  either  through  their  correspond- 
ent banks  there,  or  by  the  purchase  of  securities  from  note 
brokers.     This  shifting  of  credit,  however,  is    unimportant  as 


CREDIT  AND   BANKING  299 

compared  with  the  movement  of  money  itself.  Money  is  con- 
tinually flowing  from  New  York  to  the  interior  and  from  the 
interior  to  New  York,  according  as  it  can  be  more  profitably  em- 
ployed in  bank  reserves  in  one  place  or  the  other.  Similar  move- 
ments take  place  between  the  various  cities  of  the  country.  This 
movement,  it  will  be  noted,  is  not  one  that  is  apt  to  disturb 
financial  conditions.  On  the  contrary,  it  tends  to  prevent  ex- 
treme local  fluctuations  in  money  market  conditions  by  leading 
to  the  expansion  of  credit  where  it  is  most  needed,  and  similarly, 
to  the  contraction  of  credit  where  it  is  least  needed. 

There  is  another  kind  of  money  movement,  however,  which  is 
not  so  fortuhate  in  its  effects  upon  the  money  market.  This  is 
the  movement  of  money  out  of  bank  reserves  into  general  cir- 
culation and  out  of  general  circulation  into  bank  reserves.  The 
amount  of  money  needed  as  an  actual  hand-to-hand  medium  of 
exchange  varies  for  different  seasons  and  for  different  localities. 
The  demand  for  money  to  serve  as  the  basis  of  credit  in  bank 
reserves  and  the  demand  for  money  as  an  actual  medium  of  ex- 
change are  different  and  competing  demands.  When  more 
money  is  needed  as  a  medium  of  exchange,  reserves  have  to 
yield  and  credit  has  to  be  contracted. 

The  most  important  movement  of  this  sort  is  in  response  to  the 
annual  demand  for  money  to  be  used  in  "  moving  the  crops." 
Harvest  expenses  are  very  largely  wages,  and  these  have  to  be 
paid  in  cash.  Many  farmers,  moreover,  insist  on  receiving 
money  payments  when  they  sell  their  crops.  The  cotton  crop 
of  the  South  and  the  grain  crop  of  the  West  annually  necessitate 
the  conversion  of  bank  deposits  in  those  regions  into  money,  and 
the  negotiation  of  loans  on  the  security  of  the  crops,  the  proceeds 
of  which  are  also  largely  taken  in  cash.  The  banks  in  these  sec- 
tions of  the  country  in  turn  secure  money  from  the  banks  in 
which  they  have  deposits,  and  in  large  part  this  money  is  obtained 
directly  and  indirectly  from  the  New  York  bank  reserves.  The 
movement  of  money  from  New  York  to  the  South  and  West 
usually  commences  in  August  of  each  year  and  continues  through 
November,  when  the  return  movement  sets  in,  continuing  usu- 
ally till  February.     Despite  the  fact  that  the  New  York  bankers 


300  OUTLINES  OF  ECONOMICS 

are  forewarned  of  this  movement,  it  always  reduces  their  surplus 
reserves  and  leads  to  stringent  and  sometimes  precarious  condi- 
tions in  the  New  York  money  market,  —  conditions  which  are 
frequently  reflected  in  difficulties  in  the  money  market  through- 
out the  country. 

To  the  arbitrary  flow  of  money  to  and  from  the  treasury,  and 
to  its  movement  to  and  from  bank  reserves  and  hand-to-hand 
circulation,  there  must  be  added  the  movement  of  gold  between 
this  and  other  countries.  This  will  be  discussed  in  another 
place;  it  is  sufficient  to  note  at  this  point  that  this  external 
money  movement  is  at  the  same  time  a  cause  and  an  effect  of 
changing  money  market  conditions. 

Inelastic  Currency.  —  That  these  money  movements  have  af- 
fected the  supply  of  bank  credit  as  they  have  is  partly  at- 
tributable to  the  inelastic  character  of  our  bond-secured  bank 
currency.  Under  the  provisions  of  the  national  banking  law  that 
have  been  described,  the  variations  in  the  amount  of  bank  notes 
outstanding  have  borne  a  close  relation  to  variations  in  the  price 
of  government  bonds,  —  and  these  variations  are  affected  by 
many  other  things  than  money  market  conditions,  and  in  re- 
cent years  have  been  very  small. 

As  will  be  seen  in  Table  III,  the  creation  of  the  two  per  cent 
bonds,  payable  in  1930,  stimulated  the  issue  of  bank  notes,  be- 
cause the  federal  tax  is  only  one  fourth  of  one  per  cent  semi- 
annually on  bank  notes  secured  by  two  per  cent  bonds  as  against 
one  half  of  one  per  cent  on  notes  secured  by  bonds  paying  a 
higher  rate  of  interest.  The  relative  stability  of  the  amount 
issued  in  recent  years  has  been  noticeable,  what  increase  there 
was  being  a  natural  result  of  the  increasing  number  and  size  of 
banks.  Nor  has  the  amount  of  note  issue  responded  in  any 
marked  degree  to  the  regular  seasonal  demands  for  money  to 
move  the  crops  or  to  the  less  regular  operations  of  the  treasury 
department  or  of  the  foreign  exchanges. 

Students  of  banking  problems  have  for  many  years  thought 
that  the  national  banks  should  have  been  permitted  to  issue 
part,  if  not  all,  of  their  notes  on  the  security  of  their  general 
assets,  thus  placing  them  on  the  same  basis  as  deposits.     It  is 


CREDIT   AND    BANKING 


301 


TABLE  III 

Amounts  of  Bank  Note  Circulation  Secured  by  Specified  Classes 
of  Bonds:  1900-19151 


Security 

March  13,  1900 

Oct.  31,  1903 

Oct.  31,  1915 

Loan  1908,  3's     .     . 
Loan  1907,  4's     .     . 
Loan  1925,  4's     .     . 
Loan  1904,  5's    .     . 
Loan  1891,  2's     .     . 
Consols  1930,  2's 
Panama  Canal,  2's  . 

$56,164,820 

130,302,250 

14,697,850 

21,996,350 

20,490,150 

$1,797,580 

2,797,200 

1,410,100 

718,650 

376,003,300 

$20,377,720 
32,304,800 

600,678,600 
81,614.420 

Total      .... 

$243,651,420 

$382,726,830 

$734,975,54© 

clear  that  if  this  had  been  done  any  sudden  increase  in  the  de- 
mand for  money  as  a  circulating  medium  might  have  been  met 
by  exchanging  bank  credit  in  the  form  of  bank  notes  for  per- 
sonal credit,  or  by  the  shifting  of  bank  credit  from  the  form  of 
deposits  to  the  form  of  note  issues.  "  Asset  banking,"  as  this 
is  called,  is  used  in  Canada,  and  enables  the  banks  there  to  fur- 
nish money  for  crop  moving  purposes  without  endangering  their 
reserves.  Most  of  the  great  national  banks  of  continental 
Europe  also  issue  notes  on  the  security  of  their  general  assets. 
Under  such  a  system,  it  is  clear,  the  supply  of  bank  notes 
can  expand  automatically  with  an  increase  in  the  supply  of 
personal  credit  in  the  form  of  discountable  notes  and  bills  of 
exchange,  in  just  the  way  that  bank  deposits  expand.  To 
achieve  real  elasticity,  however,  it  is  necessary  to  provide  for 
the  ready  contraction  of  note  issues  when  the  special  demand  for 
money  is  over  as  well  as  to  provide  for  their  ready  expansion  in 
time  of  need. 

Inelastic  Reserves.  —  Under  our  national  banking  law,  banks 
have  to  stop  lending  when  their  reserves  fall  below  the  legal 
minimum.     The  central  reserves  in  New  York  have  accordingly 

1  From  Reports  of  the  Comptroller  of  the  Currency,  Finance  Reports,  1907,  p.  390 ; 
1015,  p.  571. 


302  OUTLINES.  OF    ECONOMICS 

been  real  reserves  only  in  the  sense  that  they  have  made  it  pos- 
sible for  the  banks  to  meet  extraordinary  demands  for  ready 
cash.  So  far  as  the  extension  of  credit  is  concerned  they  have 
constituted,  not  a  reserve,  but  a  dead  line.1 

This  has  often  had  serious  consequences.  It  is  a  well-tested 
principle  of  sound  banking  practice  that  about  the  worst  thing 
that  can  happen  when  bank  reserves  are  low  is  for  the  banks  to 
stop  lending.  Business  men,  otherwise  solvent,  are  not  able 
to  secure  bank  credit,  and  so  cannot  meet  their  own  obligations 
or  exchange  their  claims  against  their  debtors  for  bank  credit. 
Forced  sales  result ;  the  prices  of  securities  and  other  forms  of 
property  fall ;  the  banks  "  call  "  their  demand  loans  or  ask  for 
larger  deposits  of  collateral  securities ;  more  sales  are  forced,  and 
the  pressure  on  the  banks  for  loans  increases.  In  short,  a  general 
money  market  panic  may  come  from  suddenly  curtailing  loans 
at  a  time  when  bank  reserves  are  relatively  low.  The  wiser 
banking  policy  is  to  lend  freely  on  good  security,  but  at  in- 
creased interest  rates,  thus  automatically  restricting  loans  to  the 
more  necessitous  borrowers. 

The  Bank  of  England,  for  example,  permits  its  reserves  to 
fluctuate  between  very  wide  limits,  and  often  protects  them 
against  possible  depletion  by  reason  of  withdrawals  of  gold  to 
other  countries  by  the  simple  process  of  raising  its  discount 
rate.  Since  the  official  Bank  of  England  rate  governs  the 
general  "  open  market  rate  "  at  which  London  banks  discount 
commercial  paper,2  the  effect  is  not  only  that  the  amount  of  do- 
mestic borrowing  is  decreased,  but  also  that  the  quantity  of  for- 
eign bills  of  exchange  (normally  bought  in  large  quantities  by 
London  banks)  sent  to  London  for  discount  is  decreased.     Then, 


1  In  practice  the  law  has  not  been  rigidly  enforced,  a  warning  from  the  Comptroller 
of  the  Currency  being  generally  the  only  penalty  exacted  for  a  small  temporary 
deficit  in  the  reserves.  Nevertheless,  the  New  York  bank  reserves  have  not  often 
fallen  more  than  one  or  two  points  below  the  legal  minimum. 

*  Sometimes,  in  order  to  make  its  increased  rate  "effective*'  in  the  London  money 
market,  the  Bank  borrows  money  or  sells  securities  so  as  to  decrease  the  available 
supply  of  loanable  funds  in  the  market,  thus  compelling  the  other  London  banks 
to  increase  their  discount  rate.  Another  device  often  used  by  the  Bank  in  protecting 
its  reserves  is  that  of  slightly  increasing  the  price  at  which  it  buys  gold 


CREDIT  AND   BANKING  303 

as  the  foreign  bills  already  held  in  London  mature  into  rights  to 
demand  money  from  other  money  markets,  these  offset  claims 
of  other  money  markets  against  London  which  would  otherwise 
have  to  be  paid  by  shipping  gold. 

Absence  of  Centralized  Control.  —  It  may  have  occurred  to 
the  reader  that  some  elasticity  might  have  been  given  to  bank 
reserves  in  the  United  States  if  the  banks  holding  the  central 
reserves  had  made  it  their  practice  normally  to  hold  reserves 
considerably  larger  than  the  minimum  required  by  law,  —  re- 
serves equal  to  40  or  50  per  cent  of  their  deposits,  for  example. 
This  would  have  given  a  margin  sufficient  to  enable  them  to 
meet  withdrawals  of  gold  for  domestic  use  or  for  export  without 
suddenly  contracting  the  supply  of  loanable  funds.  All  this 
is  undoubtedly  true,  but  it  must  not  be  supposed  that  such  a 
policy  could  voluntarily  have  been  followed  by  the  New  York 
banks.  The  difficulty  was  that  the  banks  holding  the  central 
reserves  were  merely  large  commercial  banks,  interested  pri- 
marily in  securing  maximum  profits  for  their  own  stockholders, 
and  with  no  one  of  them  individually  responsible  for  the  main- 
tenance of  adequate  surplus  reserves.  For  any  one  bank  to 
have  attempted  to  remedy  the  situation  would  have  helped 
but  little.  It  would  only  have  put  itself  at  a  disadvantage  as 
compared  with  its  competitors.  And  then  there  were  other 
factors  in  the  situation  that  helped  to  keep  the  reserves  pared 
down  to  a  minimum.  It  is  not  economical  for  country  banks  to 
hold  a  much  larger  amount  of  actual  money  on  hand  than  they 
need  to  comply  with  the  law.  Moreover,  the  New  York  banks, 
competing  with  one  another  for  the  deposits  of  other  banks, 
pay  2  per  cent  interest  on  such  deposits.  In  recent  years  about 
half  of  the  aggregate  amount  of  lawful  money  in  the  possession 
of  the  national  banks  of  the  country  has  been  in  the  vaults  of 
New  York  banks.  What  surplus  reserves  were  created  from 
time  to  time  by  importations  of  gold,  by  the  transfer  of  money 
from  the  subtreasuries,  by  the  reduction  in  the  amount  of  money 
in  hand-to-hand  circulation,  or  by  a  contraction  in  the  total 
volume  of  bank  deposits,  speedily  found  their  way  to  the  New 
York  banks.     And  the  New  York  banks  speedily  found  ways  of 


304  OUTLINES   OF   ECONOMICS 

utilizing  the  additional  lending-power  created  by  these  surplus 
reserves.  Stock  exchange  speculation,  in  particular,  could 
generally  be  depended  upon  to  absorb  in  the  form  of  call  loans  a 
large  part  of  the  increased  amount  of  available  bank  credit. 
In  short,  the  operation  of  the  system  was  such  as  continually 
to  keep  the  ratio  of  reserves  to  deposits  as  close  to  the  legal 
minimum  as  possible.  Any  "  slack  "  that  might  appear  was 
quickly  taken  up. 

These  rigid  and  inelastic  reserves  were  undoubtedly  the  worst 
features  of  our  banking  system.  With  more  elastic  reserves  the 
evils  of  the  independent  treasury  system  and  of  inelastic  cur- 
rency would  not  have  been  so  great.  Money  could  have  flowed 
into  reserves  and  out  of  them  without  often  bringing  conse- 
quences more  serious  than  fluctuations  in  discount  rates. 

Steps  toward  Reform.  —  The  national  banking  system  has 
in  some  particulars  been  highly  successful.  National  bank 
notes  have  always  been  thoroughly  sound,  and  depositors,  too, 
have  been  well  protected,  for  failures  of  national  banks  have 
been  relatively  few.  The  high  standards  which  the  national 
banking  system  has  set  have  had  a  marked  influence  upon 
the  betterment  of  state  banking  laws  and  upon  their  enforce- 
ment. But  the  defects  which  have  just  been  discussed  made  it 
both  inadequate  and,  in  its  larger  aspects,  unsafe.  Students 
of  banking  problems  had  for  many  years  urged  the  need  of  re- 
form. Some  advocated  the  establishment  of  a  central  bank, 
of  the  type  that  is  found  in  almost  every  country  of  Europe. 
These  banks  hold  the  central  banking  reserves  of  their  respec- 
tive countries,  hold  the  government  deposits,  have  (usually)  a 
monopoly  of  bank  note  issue,  and  are  subject  to  a  special  meas- 
ure of  government  control.  But  ever  since  the  days  of  the 
Second  Bank  of  the  United  States  the  establishment  of  a  central 
bank  in  this  country  has  probably  been  politically  impossible. l 

•The  United  States  Bank  (i7gi-i8n)  and  the  Second  Bank  of  the  United 
States  (1816-1836)  were  large  institutions,  with  numerous  branches.  But  although 
they  issued  notes  and  held  the  treasury  funds,  they  were  not  "central  banks"  in  the 
modern  sense.  They  did  not  have  a  monopoly  of  note  issue,  for  state  banks  also 
issued  notes,  nor  did  they  hold  central  banking  reserves.  In  each  case  Congress  re- 
fused to  recharter  the  bank  at  the  expiration  of  its  original  twenty-year  charter. 


CREDIT  AND   BANKING  305 

More  interest  has  been  aroused,  however,  in  the  matter  of  elastic 
currency,  and  various  plans  for  permitting  national  banks  to 
issue  notes  secured  only  by  their  general  assets  have  from  time 
to  time  been  embodied  in  bills  introduced  in  Congress.  But 
Congress,  the  business  men  of  the  country,  and,  it  must  be  said, 
the  bankers  themselves,  were  for  the  most  part  apathetic. 

General  interest  in  the  matter  was  finally  aroused  by  the  panic 
of  1907,  in  which  the  worst  features  of  our  banking  system  stood 
out  in  clear  relief.  Banks  throughout  the  country  found  them- 
selves unable  to  meet  the  large  and  increasing  withdrawals  of 
money  by  their  depositors  and  were  unable  in  turn  to  get 
money  from  the  banks  in  New  York  and  the  other  central  reserve 
cities  in  which  they  themselves  had  deposits.  The  payment  of 
money  to  depositors  had  to  be  suspended  or  restricted,  and 
many  banks  with  perfectly  sound  assets  found  themselves,  for 
the  time  being,  technically  insolvent.  Money  was  at  a  premium. 
Clearing-house  loan  certificates  —  virtually  joint  obligations  of 
the  banks  associated  in  the  clearing  house,  issued  to  individual 
member  banks  upon  the  deposit  of  adequate  security  —  were 
used  (as  in  former  panics)  in  the  payment  of  clearing-house 
balances.  In  many  cities  the  clearing-house  loan  certificates 
were  issued  in  small  denominations  and  got  into  general  circula- 
tion by  being  paid  to  depositors  in  lieu  of  money.  Cashier's 
checks  and  other  credit  instruments  were  also  used  as  money. 
The  total  amount  of  improvised  currency  issued  during  the 
panic  is  estimated  to  have  been  over  $5oo,ooo,ooo.1  The  whole 
situation  was  such  as  to  impress  upon  thoughtful  men  the  im- 
perative need  of  banking  reform. 

The  first  tangible  result  was  the  so-called  Aldrich-Vreeland 
Act  of  1908,  which  made  temporary  provision  for  such  emer- 

In  each  case,  also,  this  occurred  when  the  country  was  temporarily  under  the  domi- 
nance of  a  strong  democratic  sentiment  opposed  to  political  or  financial  centraliza- 
tion in  any  form.  Jealousy  on  the  part  of  state  banks  was,  however,  the  immediate 
cause  of  the  demise  of  the  first  United  States  Bank,  while  the  second  succumbed  to 
the  yet  more  potent  hostility  of  Andrew  Jackson. 

1  A.  P.  Andrew,  "Substitutes  for  Cash  in  the  Panic  of  1907,"  Quarterly  Journal  oj 
Economics,  Vol.  xxii,  p.  515.  For  an  excellent  account  of  the  general  situation  at 
the  time  see  O.  M.  W.  Sprague,  History  of  Crises  under  the  National  Banking  System. 
Chap.  v. 


306  OUTLINES  OF   ECONOMICS 

gencies  as  that  of  1907  by  permitting  national  banks  to  issue 
notes,  under  a  heavy  tax,  upon  other  security  than  government 
bonds.  The  methods  utilized  were,  in  part,  those  which  had 
been  developed  by  the  banks  themselves  in  issuing  clearing- 
house certificates. 

Under  this  measure  banks  might  increase  their  note  issues  in  one  or  both 
of  two  ways.  First,  on  the  security  of  approved  state,  county,  or  municipal 
bonds  deposited  with  the  Treasurer  at  Washington.  Second,  on  the  security 
of  bonds  of  the  kinds  just  mentioned,  of  corporation  bonds,  or  of  commer- 
cial paper,  deposited  with  "National  Currency  Associations,"  which  last 
were  voluntary  organizations,  modeled  upon  clearing-house  associations, 
although  provision  was  made  for  their  organization  in  country  districts. 
These  issues  were  limited  in  amount  and  were  to  be  taxed  at  the  very  heavy 
rate  of  5  per  cent  for  the  first  month  and  1  per  cent  for  each  additional 
month  up  to  a  maximum  of  10  per  cent.  The  act,  it  is  evident,  did  not 
provide  for  a  really  elastic  currency,  varying  with  business  needs,  but 
only  for  an  emergency  currency.  In  1913  the  rate  of  taxation  was  reduced 
to  3  per  cent  for  the  first  month,  with  a  maximum  of  6  per  cent. 

For  several  years  no  notes  were  issued  under  this  statute,  but  in  1014  the 
outbreak  of  the  European  war  led  to  large  shipments  of  gold  to  Europe  and 
to  a  small-sized  panic  in  the  money  market.  The  issue  of  emergency  cur- 
rency possibly  averted  a  more  serious  panic.  Altogether,  emergency  notes 
to  the  amount  of  $386,000,000  were  issued  by  1363  different  banks.  All 
of  these  had  been  retired  before  the  Act  expired,  by  limitation,  on  June  30, 

The  Aldrich-Vreeland  Act  also  created  a  National  Monetary 
Commission,  composed  of  senators  and  congressmen,  to  devise 
a  plan  for  the  general  revision  of  the  banking  system.  The  plan 
recommended  by  this  commission  was  one  sponsored  by  Senator 
N.  W.  Aldrich  of  Rhode  Island.  It  provided  for  a  hierarchical 
organization  of  the  banks  of  the  country,  with  a  central  bank, 
the  "  National  Reserve  Association,"  at  the  top.  Banks  were 
to  be  grouped  into  local  reserve  associations,  with  functions  not 
unlike  those  of  the  national  currency  associations  of  the  Aldrich- 
Vreeland  Act.  The  whole  system  was  to  be  controlled  by  the 
banks  rather  than  by  the  government.  The  widespread  dis- 
cussion of  the  Aldrich  plan  undoubtedly  did  much  to  awaken 
interest  in  the  problem  and  to  make  the  adoption  of  the  federal 
reserve  system  possible. 


CREDIT  AND   BANKING  307 

The  Federal  Reserve  System.  —  A  revolutionary  change  in 
the  banking  system  of  the  United  States  was  brought  about  by 
the  Federal  Reserve  Act  of  1913.  Under  the  provisions  of  this 
act  the  country  has  been  divided  into  twelve  districts  and  a  cen- 
tral bank,  named  a  Federal  Reserve  Bank,  has  been  established 
in  each  district.1  The  system  is  under  the  general  supervision 
and  control  of  the  government.  At  its  head  is  the  Federal  Re- 
serve Board,  comprising  five  members  appointed  by  the  Presi- 
dent, together  with  the  Secretary  of  the  Treasury  and  the  Comp- 
troller of  the  Currency.  The  stock  of  the  various  federal  re- 
serve banks  is  owned  by  local  banks  in  the  respective  districts, 
called  "  member  banks."  National  banks  were  required  to  be- 
come member  banks,  while  state  banks  and  trust  companies 
are  permitted  to  become  member  banks,  provided  they  comply 
with  certain  standards  imposed  upon  national  banks  by  the  na- 
tional banking  law  and  with  other  requirements  set  by  the  Fed- 
eral Reserve  Board.  Each  member  bank  subscribes  to  the 
stock  of  the  federal  reserve  bank  in  an  amount  equal  to  6  per 
cent  of  its  own  capital  and  surplus.  Half  of  this  must  be  paid 
for,  and  the  other  half  remains  subject  to  call.  Any  earnings  of 
the  federal  reserve  banks  over  a  6  per  cent  dividend  to  their 
member  banks  go,  first,  to  accumulate  a  surplus  equal  to  40  per 
cent  of  the  paid  up  capital  stock,  and,  beyond  that,  to  the 
United  States  Treasury.  Each  federal  reserve  bank  is  governed 
by  a  board  of  nine  directors,  six  being  elected  by  the  member 
banks,  and  three  appointed  by  the  Federal  Reserve  Board. 

Relations  of  Federal  Reserve  Banks  and  Member  Banks.  —  The 
federal  reserve  banks  are  "  bankers'  banks  " ;  that  is,  they  do 
not  accept  the  deposits  of  individuals  nor  do  they  lend  directly 
to  individuals.  Their  most  important  relations  are  with  their 
member  banks,  and  these  may  be  summarized  under  the  heads 
of  (1)  reserves,  (2)  rediscounts,  and  (3)  note  issues. 

1.   The  federal  reserve  banks  hold  the  central  reserves  of  the 


1  The  twelve  federal  reserve  banks  are  located  at  New  York,  Boston,  Philadelphia, 
Richmond,  Atlanta,  Cleveland,  Chicago,  Minneapolis,  St.  Louis,  Kansas  City, 
Dallas,  and  San  Francisco.  The  Atlanta  bank  has  a  branch  at  New  Orleans  (witb 
1  special  district  assigned  to  it)  and  other  branches  may  be  established. 


308  OUTLINES  OF  ECONOMICS' 

system.  Three  years  are  allowed  for  the  gradual  transfer  or 
reserves  from  the  banks  which  have  held  them  in  the  past.  After 
that  period  the  requirements  are  as  follows:  A  member  bank 
may  count  as  reserve  only  (r)  money  in  its  own  vaults  and 
(2)  deposit  credits  with  the  federal  reserve  bank.  Member 
banks  in  central  reserve  cities  must  maintain  reserves  equal 
to  18  per  cent  of  their  demand  liabilities,  of  which  at  least  one 
third  must  be  money  in  their  own  vaults  and  at  least  seven 
eighteenths  deposits  in  the  federal  reserve  bank.  In  other  re- 
serve cities  member  banks  must  maintain  15  per  cent  reserves,  of 
which  at  least  one  third  must  be  in  their  own  vaults,  and  at  least 
six  fifteenths  must  be  a  federal  reserve  bank  deposit.  Banks 
in  other  cities  or  rural  districts  must  keep  12  per  cent  reserves ; 
at  least  one  third  in  their  own  vaults  and  at  least  five  twelfths 
in  the  federal  reserve  bank.  The  federal  banks,  in  turn,  have  to 
keep  minimum  reserves  of  -5  per  cent  of  their  deposits. 

These  provisions  for  minimum  reserves  of  definite  size  must  be 
interpreted  as  being,  in  part  at  least,  a  concession  to  American 
habits  and  prejudices.  But  the  Federal  Reserve  Board  is 
authorized  to  suspend  temporarily  any  of  these  reserve  require- 
ments, imposing  a  graduated  tax  upon  the  amounts  by  which 
the  reserves  fall  below  the  stated  minimum  limit.  It  is  to  be 
expected,  moreover,  that  the  federal  reserve  banks  will  normally 
hold  reserves  much  larger  than  those  required  by  law.  This 
in  itself  will  introduce  a  large  measure  of  elasticity  into  the  situa- 
tion. 

2.  Rediscounting  means  the  purchase  by  one  bank  of  notes 
and  bills  of  exchange  held  by  another,  the  purchasing  bank  being 
protected  by  the  selling  bank's  endorsement  of  the  discounted 
paper.  Rediscounting  has  not  been  a  common  feature  of  Ameri- 
can banking  practice,  and  there  has  even  been  a  distinct  prejudice 
against  it,  although  it  is  very  common  in  Europe.  The  new  law 
makes  it  an  essential  part  of  the  federal  reserve  system.  Federal 
reserve  banks  may  rediscount  (for  their  member  banks)  short- 
time  notes  and  bills  of  exchange  "  issued  or  drawn  for  agricul- 
tural, industrial,  or  commercial  purposes,"  and  conforming 
to  certain  specifications  which  have  been  carefully  formulated 


•   CREDIT  AND   BANKING  309 

by  the  Federal  Reserve  Board.  The  privilege  of  rediscount  is 
not  extended  to  notes  and  bills  of  exchange  issued  "  for  the 
purpose  of  carrying  or  trading  in  stocks,  bonds,  or  other  invest- 
ment securities,  except  bonds  and  notes  of  the  United  States." 
The  purpose  of  this  restriction  is  not  only  to  prevent  the  resources 
of  the  federal  reserve  banks  from  being  used  to  finance  specula- 
tion, but  also  to  limit  their  rediscounts  to  so-called  "  self-liqui- 
dating paper,"  that  is,  to  notes  and  bills  of  exchange  held  against 
loans  which  the  borrowers  will,  in  the  ordinary  course  of  business, 
be  able  to  repay  from  the  proceeds  of  the  sales  of  the  goods  pro- 
duced or  purchased  with  the  aid  of  the  borrowed  funds. 

The  most  important  general  advantage  of  this  new  redis- 
counting  system  is  the  help  it  will  give  in  the  development  of  a 
thoroughly  elastic  supply  of  deposit  credit,  expanding  and  con- 
tracting with  the  number  and  magnitude  of  business  transac- 
tions. When,  for  example,  the  reserves  of  certain  member 
banks  are  too  low  to  permit  them  to  advance  deposit  credits 
to  their  customers  in  the  desired  quantities  upon  even  the  sound- 
est instruments  of  personal  credit,  they  may  replenish  their 
reserves  by  sending  part  of  their  holdings  of  bills  and  notes  to  the 
federal  reserve  banks  for  rediscount.  In  order  to  equalize  the 
supply  of  bank  credit  in  different  parts  of  the  country  the  Fed- 
eral Reserve  Board  may  permit  and  even  require  certain  federal 
reserve  banks  to  rediscount  commercial  paper  for  other  federal 
reserve  banks.  The  Federal  Reserve  Board  also  has  general 
supervising  power  over  the  whole  rediscounting  system,  includ- 
ing power  to  revise  the  rediscount  rates  of  the  different  federal 
reserve  banks. 

3.  Under  the  new  system,  national  banks  may  still  continue 
to  issue  notes,  as  in  the  past,  if  they  wish.  The  existing  national 
bank  notes,  constituting  about  one  fifth  of  the  aggregate  amount 
of  money  in  the  country,  could  not  be  suddenly  withdrawn  from 
circulation  without  serious  consequences.  But  the  Federal 
Reserve  Act  provides  that  the  national  banks  may  gradually 
get  rid  of  their  note-issue  liabilities  by  selling  the  government 
bonds  they  hold  as  security  for  their  notes  to  the  federal  reserve 
banks  at  par.     The  federal  reserve  banks,  if  they  wish,  may 


310  OUTLINES   OF   ECONOMICS 

utilize  these  bonds  as  security  for  the  issue  of  federal  reserve 
bank  notes,  which  in  all  essentials  are  like  national  bank  notes. 
The  extent  to  which  national  banks  will  give  up  their  note  issues 
will  depend  very  largely  upon  the  price  of  government  bonds. 

More  important,  however,  are  federal  reserve  notes,  issued  by 
the  federal  reserve  banks  (i)  in  exchange  for  gold,  thus  becoming 
virtually  gold  certificates,  and  (2)  upon  the  security  of  redis- 
counted  paper  held  by  them.  A  100  per  cent  reserve  is  held 
against  notes  issued  in  exchange  for  gold ;  a  40  per  cent  reserve 
has  to  be  held  against  notes  issued  on  the  security  of  rediscounted 
paper.  This  last  reserve  requirement  may,  in  emergency,  be 
waived  by  permission  of  the  Federal  Reserve  Board,  a  graduated 
tax  being  imposed  upon  deficiencies  in  the  reserve.  This  makes 
it  possible,  it  will  be  seen,  for  member  banks  to  secure  currency  for 
their  own  borrowers  and  depositors  by  sending  paper  to  the 
federal  reserve  banks  to  be  rediscounted,  taking  the  proceeds 
of  such  rediscounts  in  federal  reserve  notes.  This  means  that 
when  the  country  needs  more  money  for  hand-to-hand  circula- 
tion it  can  get  it  by  exchanging  personal  credit  instruments  for 
federal  reserve  notes.  Bank  credit  in  the  form  of  bank  notes 
can  now  be  expanded  quite  as  readily  as  bank  credit  in  the  form 
of  deposits.  But  it  is  not  yet  certain  that  an  adequate  mecha- 
nism has  been  provided  for  the  speedy  contraction  of  the  note  issue 
when  the  special  needs  that  called  for  its  expansion  have  passed. 
Federal  reserve  notes  are  redeemable  at  the  issuing  banks  and 
(out  of  a  redemption  fund  maintained  by  the  banks)  at  the  treas- 
ury in  Washington,  and  no  federal  reserve  bank  which  has  re- 
ceived the  notes  of  another  federal  reserve  bank  is  permitted 
to  pay  them  out,  but  must  return  them  promptly  to  the  issuing 
bank  "  for  credit  or  redemption."  Much  depends  then,  so  far 
as  contraction  is  concerned,  upon  the  rapidity  with  which  federal 
reserve  notes  find  their  way  back  to  some  federal  reserve  bank. 

Other  Functions  of  the  Federal  Reserve  Banks.  —  In  addition 
to  being  "  bankers'  banks,"  the  federal  reserve  banks,  it  is 
expected,  will  be  bankers  for  the  federal  government.  They 
may,  under  the  law,  be  used  as  depositories  for  all  the  general 
funds  of  the  government  and  may  serve  as  "  fiscal  agents  "  of 


CREDIT  AND   BANKING  31 1 

the  government  in  various  treasury  operations.  This  will  make 
it  possible  for  the  government  to  use  modern  and  economical 
methods  in  caring  for  its  receipts  and  making  its  payments,  and 
should  also  prove  of  advantage  in  its  borrowing. 

The  federal  reserve  banks  are  also  empowered  to  buy,  sell,  and 
borrow  gold  coin  and  bullion,  the  securities  of  the  federal  govern- 
ment, and  the  warrants  and  other  short-time  obligations  of  states 
and  municipalities.  They  may  also  buy  and  sell  bills  of  exchange 
arising  out  of  either  foreign  or  domestic  trade.  This  last  power 
enables  them,  in  case  of  need,  to  come  to  the  relief  of  banks  not 
members  of  the  system.  Buying  bills  of  exchange  from  other 
banks  differs  from  "  rediscounting  "  only  in  that  in  the  latter 
process  the  bills  to  be  rediscounted  are  normally  and  usually 
exchanged  for  deposit  credits  or  bank  notes.  Under  the  law, 
federal  reserve  notes  cannot  be  issued  upon  the  security  of  "  pur- 
chased "  paper,  but  only  upon  paper  "  rediscounted  "  for  member 
banks,  nor  can  federal  reserve  banks  give  deposit  credit  to  banks 
not  in  the  system.  This  means  that  since  "  purchases  "  will 
usually  involve  a  direct  drain  upon  the  reserves  of  the  federal 
banks,  their  power  of  "  purchase  "  is  much  more  restricted  than 
their  power  of  "  rediscount." 

But  there  is  a  yet  more  important  aspect  of  these  authorized 
"  open-market  operations  "  in  commercial  paper.  Only  through 
the  use  of  this  power  can  the  federal  reserve  banks  hope  to  make 
their  discount  rates  "  effective  "  in  the  money  market.  Only 
in  this  way  can  they  expect  to  "  put  on  the  brakes  "  when  they 
think  that  bank  credit  is  being  expanded  with  dangerous  rapidity 
or  encourage  free  lending  on  the  part  of  the  banks  when  condi- 
tiens  are  such  as  to  make  that  policy  seem  desirable.  Only  in 
this  way,  moreover,  can  they  protect  their  gold  reserves  by  the 
use  of  devices  similar  to  those  which  the  Bank  of  England  and 
other  European  banks  have  found  effective.  The  existence  of 
an  "  open  market  "  for  commercial  paper  means  merely  that 
commercial  paper,  instead  of  being  held  till  maturity  by  the 
bank  first  discounting  it,  may  be  bought  and  sold  freely,  and 
may  move  from  one  city  to  another  and  even  from  one  country 
to  another,  according  to  differences  in  prevailing  discount  rates. 


312  OUTLINES  OF  ECONOMICS 

In  the  United  States  open  market  operations  of  this  kind  are  not 
yet  of  sufficient  magnitude  to  give  the  federal  reserve  banks  any 
large  opportunity  for  exerting  their  influence.  They  are  con- 
sequently endeavoring  to  stimulate  the  growth  of  open-market 
operations. 

The  federal  reserve  system  has  been  very  carefully  devised 
for  the  purpose  of  getting  rid  of  the  principal  evils  inherent  in 
the  national  banking  system  as  it  was.  If  given  a  thorough  and 
fair  test,  it  should  accomplish  that  purpose.  There  is  some 
danger  that  the  new  system  may  make  possible  a  too  easy  and 
too  rapid  expansion  of  bank  credit  in  periods  of  business  pros- 
perity, ending  perhaps  in  reaction  and  crisis.  But  this  danger 
is  inseparable  from  any  really  elastic  system  of  bank  credit. 
With  a  wise  exercise  of  the  powers  which  the  Federal  Reserve 
Board  has  over  discount  rates  and  reserves,  the  alternations  of 
periods  of  business  prosperity  and  periods  of  business  depression 
should  be  less  frequent  and  less  violent  than  in  the  past. 

The  most  formidable  obstacle  to  the  success  of  the  federal  reserve  system 
now  apparent  is  the  possible  lack  of  cordial  cooperation  on  the  part  of  the 
banks  — :  especially  the  smaller  banks — of  the  country.  Very  few  state  banks 
and  trust  companies  have  become  member  banks,  while  a  few  member  banks 
have  given  up  their  national  bank  charters  and  have  withdrawn  from  the 
system.  Despite  the  fact  that  the  Federal  Reserve  Act  modified  the  na- 
tional banking  law  by  permitting  national  banks  to  engage  in  various  kinds 
of  banking  operations  which  had  previously  been  prohibited,  some  of  the 
bankers  feel  that  membership  in  the  system  decreases  their  banking  profits. 
Member  banks  no  longer  get  interest  on  their  reserve  deposits  (although 
this  is  compensated  for,  at  least  in  part,  by  the  reduction  in  the  size  of  the 
required  reserves)  and,  if  they  utilize  the  federal  reserve  banks  as  clearing 
and  collection  agencies  for  checks  drawn  upon  other  banks  in  the  system, 
they  lose  some  of  the  profits  from  certain  charges  that  had  previously  been 
made  for  collections  and  exchange.  The  advantages  of  the  system  to  in- 
dividual banks  will  appear  most  clearly  at  time  of  crisis.  But  lessons  of 
periods  like  that  of  1907  are  soon  forgotten.  The  greatest  advantages  of 
the  system,  however,  are  its  effects  upon  the  commercial  interests  of  the 
country  as  a  whole.  A  particular  banker  may  feel  that  he  can  share  in 
many  of  the  general  advantages  of  the  system  without  membership  in  it. 
It  is  to  be  hoped  that  this  absence  of  a  sense  of  individual  responsibility  for 
the  general  banking  situation  may  not  develop  so  far  as  to  prevent  the  fed- 
eral reserve  system  from  attaining  its  maximum  usefulness. 


CREDIT  AND   BANKING 


3*3 


TABLE  IV 

Combined  Resources  and  Liabilities  op  the  Federal  Reserve 
Banks:  July  21,  19161 

(In  thousands  of  dollars) 


Resources 

Liabilities 

377.343 

Capital  paid  in     .     .     . 

S5,i83 

Five  per  cent  redemption 

Government  deposits     . 

54,277 

fund  against  federal  re- 

Member bank  deposits  . 

492,000 

serve  bank  notes  .     .     . 

4  5° 

Federal  reserve  notes 2  . 

10,120 

Bills  discounted  for  mem- 

Federal  reserve   bank 

bers    

28,937 

1,692 

Bills  bought  in  open  mar- 

• •     .251 

ket      

85,382 

United  States  bonds     .     . 

49,746 

One-year  treasury  notes    . 

7,190 

Municipal  warrants      .     . 

27,723 

Federal  reserve  notes,  net 

20,014 

Other  resources   .... 

16,738 

Total 613,523 


Total 613,523 


The  Present  Position  of  State  and  Private  Banks.  —  The 
figures  in  Table  V  give  only  a  partial  idea  of  the  present  posi- 
tion of  banking  in  the  United  States,  for  while  they  are  com- 
plete as  to  national  banks,  there  were,  in  1915,  over  3000 
other  banks  which  failed  to  make  reports  to  the  Comptroller 
of  the  Currency. 

"State  banks,"  in  the  narrow  sense,  include  only  corporations  chartered 
by  the  individual  states  to  conduct  a  general  commercial  banking  business. 
In  a  broader  sense  savings  banks  and  trust  companies  incorporated  under 
state  law  may  be  said  to  be  state  banks. 

1  Compiled  from  statements  in  Federal  Reserve  Bulletin,  Vol.  ii,  pp.  426,  427. 

2  Federal  reserve  notes  to  the  amount  of  $175,219,000  were  outstanding  at  this 
date  but  a  large  porportion  of  these  were  covered  by  gold  set  aside  for  the  purpose 
(and  not  included  in  the  statement  of  resources)  and  others  remained  in  the  hands 
of  issuing  banks.     The  amount  in  circulation  was  $154,038,000. 


314 


OUTLINES  OF   ECONOMICS 


TABLE  V 

Number  of  Banks  and  Amount  of  Deposits  in  Specified  Kinds  o* 
Banks:  191 5 l 


Number 
of  Banks 


Deposits* 


State  banks 

Savings  banks  .... 
Private  banks  .... 
Loan  and  trust  companies 
National  banks   .... 


14,598 
2,iS9 
1,036 
1,664 
7,605 


$3?277,772,ooo 

4,997,706,000 

134,410,000 

4,204,596,000 

6,569,859,000 


Total 


27,062 


$19,184,343,000 


Savings  banks  do  not  usually  do  a  commercial  banking  business ;  that  is, 
they  are  not  engaged  in  the  sale  of  bank  credit  in  a  form  that  can  be  used  in 
making  payments.  Their  deposit  accounts  are  not  usually  transferable  by 
means  of  checks.  They  receive  deposits  of  small  savings  and  invest  them 
in  long  time  securities,  such  as  real  estate  mortgages  and  bonds  of  various 
sorts.  They  perform  an  important  social  service  by  stimulating  saving  and 
by  increasing  the  financial  power  of  small  investors  through  concentrating 
and  combining  their  resources.  Savings  banks  are  organized  either  as  cor- 
porations or  as  mutual  societies  managed  by  a  board  of  trustees  acting  for 
the  depositors.     The  latter  type  is  especially  common  in  the  eastern  states. 

Trust  companies  were  at  first  organized  to  take  charge  of  trust  funds  and 
to  act  as  executors  and  administrators  of  estates.  They  have,  however, 
developed  the  functions  of  both  savings  banks  and  commercial  banks,  and 
have  even  entered  such  specialized  banking  fields  as  foreign  exchange  and 
the  underwriting  of  corporation  securities.  They  have  thus  the  character 
of  free  lances  in  the  banking  field.  Their  banking  functions  have  developed 
so  rapidly  that  in  many  states  they  have  been  put  under  no  such  rigid  control 
as  is  exercised  over  state  and  savings  banks. 

Private  banks  are  of  two  very  distinct  types.  Some  are  small  unincor- 
porated banks  in  country  towns.  Others  are  great  concerns  in  the  financial 
centers  which  deal  in  investment  securities,  buy  and  sell  foreign  exchange, 
finance  great  corporate  undertakings,  and,  in  some  cases,  act  as  brokers  in 
the  stock  market. 

It  is  impossible,  in  fact,  to  draw  a  definite  line  between  "banking"  and 

1  Compiled  from  Report  of  Comptroller  of  the  Currency,  Finance  Report,    1915, 

pp  533.  SOS- 

2  Exclusive  of  inter-bank  deposits  and  postal-savings  deposits. 


CREDIT  AND   BANKING  315 

other  financial  undertakings.  Building  and  loan  associations,  private  money- 
lenders, note  brokers,  dealers  in  investment  securities,  life  insurance  com- 
panies, etc.,  frequently  perform  functions  which  are  very  much  like  some 
kinds  of  "banking."  But  banking  as  the  institution  which  converts  per- 
sonal credit  into  bank  credit  in  the  form  of  deposit  accounts  and  bank  notes 
is  a  clearly  defined  thing,  and  has  a  distinct  economic  significance  of  its  own. 

QUESTIONS 

1.  Explain  the  various  items  in  the  published  "statement"  of  a  na- 
tional bank. 

2.  Because  a  national  bank  can  buy  interest-bearing  government  bonds 
and  use  them  as  security  for  its  own  issues  of  paper  money,  advocates  of 
government  paper  money  issues  have  alleged  that  it  gets  "double  interest 
on  its  money."     Is  this  true? 

3.  How  should  one  compare  the  profitableness  of  issuing  notes  with  the 
profitableness  of  extending  deposit  credit? 

4.  What  restrictions  does  your  state  impose  on  state  banking  corpora- 
tions? 

5.  Report  on  the  note-issue  systems  of  the  Bank  of  England,  the  Bank 
of  France,  the  Imperial  Bank  of  Germany,  and  the  Canadian  banks. 

6.  Report  upon  the  relative  advantages  of  the  promissory  note  and  the 
bill  of  exchange  as  instruments  of  commercial  credit. 

7.  Compare  the  provisions  of  the  Aldrich  plan  with  those  of  the  federal 
reserve  system. 

8.  Does  the  supply  of  bank  credit  involve  the  sacrifice  of  "waiting" 
on  the  part  of  anyone  ?     Who  are  the  real  or  ultimate  lenders  ? 

9.  What  are  bank  acceptances?  trade  acceptances?  commodity  paper ? 

10.  Are  bank  notes  more  closely  analogous  to  government  paper  money 
or  to  bank  deposits? 

11.  What  points  of  superiority  have  bank  notes  over  government  paper, 
money? 

REFERENCES 

(See  also  references  for  Chapter  XIV.) 

Comptroller  of  the  Currency.     Annual  Reports. 

Conant,  C.  A.    History  of  Modem  Banks  of  Issue. 

Conway,  Thomas,  and  Patterson,  E.  M.     The  Operation  of  the  New  Bank 

Act. 
Dunbar,  C.  F.     Chapters  on  the  Theory  and  History  of  Banking. 
Federal  Reserve  Board.    A nnual  Reports ;  Federal  Reserve  Bulletin  (monthly) 
Holdsworth,  J.  T.     Money  and  Banking. 
Knox,  J.  J.     History  of  Banking  in  the  United  States. 
Laughlin,  J.  L.  (editor).     Banking  Reform. 


316  OUTLINES  OF   ECONOMICS 

National  Monetary  Commission.  Publications.  (A  series  of  over  forty  mono- 
graphs by  different  authors,  giving  as  a  whole  the  best  available  history 
of  banking  in  the  United  States  and  the  best  accounts  in  English  of  the 
banking  institutions  of  other  countries.) 

Pratt,  S.  S.     The  Work  of  Wall  Street. 

Sumner,  W.  G.     History  of  Banking  in  the  United  States. 

Willis,  H.  P.     The  Federal  Reserve;  American  Banking. 

Withers,  Hartley.     The  Meaning  of  Money. 


CHAPTER  XVI 
OTHER   PROBLEMS   IN    MONEY   AND   BANKING 

The  Value  of  Money.  —  We  have  not  as  yet  answered  one 
very  important  question,  and  that  is,  "  What  determines  the 
value  of  money?  "  Now  by  the  "  value  of  money  "  we  mean 
the  purchasing  power  of  money  as  reported  or  expressed  by 
the  money  prices  of  other  things.  There  is  no  such  thing  in 
fact  as  "  the  general  purchasing  power  of  money,"  although  we 
have  found  it  convenient  to  use  that  and  similar  expressions. 
Money  has,  in  reality,  a  large  number  of  different  values,  ex- 
pressed by  the  different  quantities  of  different  things  that  it 
will  purchase.  If  the  price  of  wheat  is  one  dollar  per  bushel, 
then  one  value  —  the  wheat  value  —  of  money  is  a  bushel  per 
dollar.  Similarly,  the  purchasing  power  of  money  in  sirloin 
steaks  may  be  four  pounds  per  dollar.  But  how  are  we  to 
blend  sirloin  steaks,  wheat,  and  other  things  into  one  concept? 
The  notion  of  the  general  value  of  money  is  simply  a  useful 
abstraction,  based  on  a  broad  view  of  all  its  different  specific 
values. 

When  we  fix  our  attention  upon  changes  in  the  various  pur- 
chasing powers  of  money,  however,  we  are  able  to  make  a  dis- 
tinction between  changes  that  are  widespread  and  general, 
and  changes  that  affect  only  one  or  two  commodities.  For 
example,  a  new  invention  may  decrease  the  price  of  a  particular 
commodity,  without  affecting  the  prices  of  other  things  except 
(if  the  demand  for  the  commodity  is  elastic)  by  shifting  demand 
from  other  things  to  the  commodity  in  question,  —  an  effect 
which  would  usually  be  slight  so  far  as  the  price  of  any  one  of 
these  other  things  is  concerned,  for  the  demand  would  very 
likely  be  shifted  from  many  different  lines  of  consumption.  Or, 
if  the  demand  for  the  commodity  in  question  is  relatively  in- 

317 


318  OUTLINES   OF   ECONOMICS 

elastic,  a  diminution  in  its  price  may  increase  the  demand  for 
other  things.  But  there  are,  on  the  other  hand,  price  fluctua- 
tions which  are  widespread  and  which  show  a  general  trend  in 
one  direction  or  the  other,  and  these  we  may  call,  with  substan- 
tial accuracy,  changes  in  the  value  of  money.  What  are  the 
underlying  causes  of  these  general  changes  in  the  values  of 
money  ? 

The  Nature  of  the  Problem.  —  Our  first  impulse,  perhaps, 
is  to  suggest  that  there  is  no  new  problem  here,  that  the  value 
of  money  is  to  be  determined  in  the  way  that  other  values  are 
determined,  and  to  seek  to  frame  an  explanation  in  terms  of 
marginal  utility  and  the  general  laws  of  supply  and  demand. 
But  the  task  is  not  so  simple  as  that.  The  analysis  of  marginal 
utility,  it  is  true,  formed  the  basis  of  our  explanation  of  the 
shifting  of  demand  from  one  commodity  to  another,  but  it  does 
not  help  us  to  explain  the  demand  for  money.  Marginal 
utility  depends  upon  the  capacity  of  things  to  satisfy  human 
wants,  and  money  does  not  directly  satisfy  a  single  human 
want,  except  the  abnormal  wants  of  the  miser.  We  want 
money  only  as  we  want  the  things  that  money  will  buy  for  us. 

And  when  we  turn  to  "  supply  and  demand  "  we  find  at  first 
little  help.  For,  it  will  be  remembered,  when  we  were  discuss- 
ing the  relations  between  the  prices  of  things  and  their  supply 
and  demand,  we  arbitrarily  limited  ourselves  to  the  consider- 
ation of  one  commodity  at  a  time.  That  is,  we  assumed  that 
the  money  price  of  the  one  commodity  we  were  considering  was 
alone  variable,  and  that  the  prices  of  all  other  things  remained, 
for  the  time  being,  constant.  The  consumer  whom  we  pictured 
as  willing  to  buy  a  certain  amount  of  a  commodity  at  a  certain 
price  or  a  larger  amount  at  a  lower  price,  was,  by  our  premises, 
merely  comparing  variable  dollars'  worths  of  the  commodity  in 
question  with  fixed  dollars'  worths  of  other  things.  All  the 
values  of  money,  save  one,  were  held  constant,  so  that  the 
imaginary  consumer  simply  had  to  compare  the  utility  of  larger 
and  smaller  marginal  dollars'  worths  of  the  one  commodity 
with  their  cost  measured  in  a  dollar  that  represented  perfectly 
definite  amounts  of  all  other  things.     Now  the  problem  of  the 


OTHER   PROBLEMS   IN   MONEY   AND    BANKING       319 

v^alue  of  money  (understood  as  the  problem  of  general  changes 
in  the  different  values  of  money)  cannot  be  approached  in 
that  way.  For  the  problem  of  th~  value  of  money  is  merely 
the  obverse  of  the  problem  of  the  money  values  of  all  other 
things.  If  we  were  studying  the  wheat  value  of  money  we 
could  assume  the  sirloin-steak  value  of  money  to  be  held 
constant.  But  our  present  problem  is  that  of  the  wheat  value 
of  money  and  the  sirloin-steak  value  of  money  and  all  other 
values  of  money.  We  can't  resort  to  the  strategy  of  breaking 
the  sticks  in  our  bundle  one  by  one. 

The  Quantity  of  Money  and  the  Values  of  Money.  —  All 
this  does  not  mean  that  there  is  no  such  thing  as  a  "  demand 
foi  money."  Using  the  word  money  in  its  broadest  sense, 
including  all  "  rights  to  receive  money  "  that  are  used  in  mak- 
ing payments,  it  is  clear  that  every  sale  of  a  commodity  may 
be  viewed  as  a  purchase  of  money,  and  every  purchase  of  a 
commodity  as  a  sale  of  money.  Going  a  step  farther,  and 
remembering  that  one  wants  money  only  because  of  the  things 
money  will  buy,  we  may  say  that  every  sale  of  one  commodity 
is  a  purchase  of  the  power  of  acquiring  other  things.  A  seller 
cares  nothing  about  the  quantity  of  money  —  the  number  of 
dollars  —  he  gets  in  exchange  for  his  goods,  except  in  so  far  as 
these  dollars  have  certain  exchange  relations  with  other  things, 
including  the  things  he  buys  as  a  consumer  and  the  things  he 
pays  for  under  the  head  of  "  expenses  of  production."  Simi- 
larly, a  buyer  cares  not  how  much  money  he  parts  with  in  ex- 
change for  a  definite  quantity  of  goods,  except  in  so  far  as  the 
money  has  alternative  uses  of  greater  or  less  importance.  The 
quantity  of  money  —  the  number  of  dollars  in  the  aggregate 
supply  of  the  instruments  in  which  payments  are  made  —  has 
no  significance  apart  from  the  values  of  the  dollars. 

These  two  things  —  quantity  and  value  —  are  in  the  case 
of  money  bound  together  in  a  peculiar  way.  They  are,  in  a 
very  real  sense,  not  only  interdependent  but  interchangeable. 
A  small  amount  of  money  of  high  purchasing  power  per  unit 
will  meet  the  needs  of  both  buyer  and  seller  just  as  well  as  a 
larger  amount  of  money  of  lower  purchasing  power  per  unit. 


320  OUTLINES  OF  ECONOMICS 

What  are  the  conditions  under  which  a  general  change  in  the 
values  of  dollars  is  possible?  Let  us  simplify  the  problem  by 
assuming  that  the  change  is  absolutely  general  and  uniform ; 
that  if,  for  example,  the  price  of  a  bushel  of  wheat  is  seventy-five 
cents  and  the  price  of  a  bushel  of  corn  is  fifty  cents,  an  increase 
in  the  price  of  wheat  to  a  dollar  and  a  half  is  accompanied  by 
an  increase  in  the  price  of  corn  to  a  dollar,  and  by  a  similar 
doubling  of  the  money  prices  of  all  other  commodities  and 
services.  Things  retain,  we  shall  assume,  precisely  the  same 
exchange  relations  as  before,  except  with  reference  to  money. 
If  prices  have  thus  increased,  all  the  values  of  money  have  di- 
minished by  one  half.  As  an  intermediary,  then,  as  a  means  of 
obtaining  other  things,  money  has  only  half  its  former  potency. 

Sellers  are  demanding  and  receiving  twice  as  many  dollars 
as  before  for  given  quantities  of  goods ;  buyers  are  offering  and 
paying  twice  as  many  dollars  as  before  per  unit  of  goods  pur- 
chased. Remembering  now  that  we  are  using  the  word  money 
in  its  broadest  sense,  including  exchangeable  credit  instru- 
ments, it  is  evident  that  twice  as  much  money  as  before  passes 
from  buyer  to  seller  in  exchange  for  every  unit  of  everything 
else  that  passes  from  seller  to  buyer.  But  this  means  that 
one  of  two  possible  conditions  must  exist.  Either  (i)  fewer 
exchanges  are  being  made,  or  (2)  exactly  twice  as  much  money 
as  before  is  being  exchanged  for  goods  and  services.  So  we 
reach  the  very  important  conclusion  that  there  must  be  a 
definite  relation  between  general  changes  in  the  values  of 
money  and  changes  in  its  quantity.  We  need  not  as  yet  con- 
cern ourselves  with  the  question  of  which  of  these  two  related 
things  is  cause  and  which  is  effect.  But  that  these  two  things 
are  inseparably  bound  up,  the  one  with  the  other,  should  now 
be  clear. 

We  may  now  state  this  principle  in  a  somewhat  broader 
form  :  //  the  number  of  units  of  goods  and  services  of  every  sort 
annually  exchanged  for  money  remains  constant,  any  increase  or 
decrease  in  the  amount  of  money  used  in  making  payments  must 
be  accompanied  by  an  exactly  proportionate  general  increase  or 
decrease  in  prices.     It  is  not  necessary  for  the  truth  of  this 


OTHER  PROBLEMS   IN   MONEY  AND   BANKING       32 1 

theorem  that  all  prices  should  change  in  the  same  proportion. 
The  general  change  in  prices  may,  for  example,  be  upward, 
but  some  prices  may  rise  by  a  smaller  proportion  or  may  even 
fall,  provided  these  are  offset  by  sufficiently  large  increases 
in  the  prices  of  other  things.  An  "  exactly  proportionate  " 
general  change  in  prices  merely  means  such  changes  in  specific 
prices  as  will  make  possible  an  unchanged  volume  of  transac- 
tions with  the  increased  or  decreased  number  of  dollars  used  in 
making  payments.  A  general  increase  or  decrease  in  price  is 
of  course  identical  with  a  general  decrease  or  increase  in  the 
various  specific  values  of  money. 

The  Equation  of  Exchange.  —  Some  aspects  of  the  general 
relation  bet  veen  prices  and  the  quantity  of  money  can  be  con- 
veniently represented  by  using  algebraic  symbols.  Let  M 
represent  the  total  amount  of  money  in  circulation,  and  let  V 
represent  its  rate  of  turnover,  or  velocity  of  circulation,  that 
is,  the  average  number  of  times  the  various  dollars  in  circulation 
are  exchanged  for  goods  or  services  during  the  year.  .  Then 
MV  will  represent  total  money  payments,  measured  in  money 
units.  Let  T  represent  the  total  volume  of  trade,  or,  more 
accurately  expressed,  the  total  number  of  units  of  commodities 
and  services  exchanged  for  money  during  the  year.  Finally, 
let  P  represent  the  average  price  per  unit  paid  for  these  com- 
modities and  services.  The  equation  of  exchange  may  now  be 
stated  in  its  simplest  form : 

MV  =  PT. 

This  equation,  it  is  obvious,  amounts  to  the  statement  that 
the  quantity  of  money  in  circulation,  multiplied  by  its  average 
rate  of  turnover,  is  equal  to  the  average  price  per  unit  paid  for 
commodities  and  services,  multiplied  by  the  number  of  units 
sold.  This,  in  turn,  is  equivalent  to  the  yet  simpler  statement 
that  the  total  amount  of  money  paid  for  things  during  the  year 
equals  the  sum  of  the  prices  of  all  the  units  purchased.  Stated 
in  this  way,  the  equation  of  exchange  is  readily  seen  to  be 
necessarily  true.  In  fact,  it  is  a  truism,  —  an  identity,  almost, 
rather  than  an  equation.     But  it  is  none  the  less  significant, 


322  OUTLINES  OF   ECONOMICS 

for  the  truism  which  it  states  is  one  which  has  very  often  been 
forgotten. 

Up  to  this  point  we  have  simplified  our  problem  by  counting 
as  "  money  "  everything,  including  credit  instruments,  expressed 
in  terms  of  dollars  and  accepted  in  payment  for  other  things. 
But  there  are  some  important  problems  connected  with  the 
relation  of  changes  in  the  quantity  of  the  generally  accepted 
media  of  exchange  (money  in  the  "  narrower  sense  ")  to  changes 
in  prices.  So  we  shall  now  let  M  represent  the  quantity  of  the 
generally  acceptable  media  of  exchange,  including  metallic 
money,  government  paper  money,  and  bank  notes.  The  sym- 
bol M'  will  be  used  to  represent  the  quantity  of  the  trans- 
ferable "  rights  to  demand  money  "  that  are  usee  in  making 
payments.  These  consist,  almost  entirely,  of  bank  deposits 
subject  to  check.    Then  the  equation  of  exchange  becomes: 

MV  +  M'V  =  PT. 

This  is  a  statement  in  algebraic  symbols  of  the  fact  that  the 
amount  of  money  in  circulation,  multiplied  by  its  rate  of  turn- 
over, together  with  the  amount  of  bank  deposits  subject  to 
check,  multiplied  by  their  average  rate  of  turnover,  must  be 
equal  to  average  unit  prices,  multiplied  by  the  number  of  units 
of  things  exchanged  for  money  or  for  deposit  credit.  This  equa- 
tion is  identical  with  the  other  one,  except  that  a  distinction  is 
now  made  between  money  and  bank  deposits.  The  principal 
advantage  of  the  use  of  the  equation  of  exchange,  in  fact,  is 
that  it  enables  us  to  discuss  the  relations  between  general 
changes  in  prices  and  changes  in  the  amount  of  metallic  and 
paper  money  without  becoming  involved  in  difficulties  of  analy- 
sis and  of  exposition  that  would  otherwise  be  very  formi- 
dable. The  problem  becomes  simply  that  of  the  relations  be- 
tween M  and  P  in  the  equation  of  exchange. 

If  M  and  M'  increase  in  equal  proportion,  while  V,  V,  and 
T  remain  fixed,  P  must  also  increase  proportionally.  That  is, 
all  other  things  being  equal,  an  increase  in  the  amount  of  money 
in  circulation  and  in  bank  deposits  must  be  accompanied  by  a 
proportionate  increase  in  prices.     To  what  extent,  in  fact,  are 


OTHER  PROBLEMS   IN  MONEY  AND   BANKING       323 

these  "  other  things  "  likely  to  remain  equal?  In  the  first  place 
a  sudden  increase  in  the  amount  of  money  in  circulation  is 
very  sure  to  increase  T,  the  total  volume  of  trade,  by  leading 
to  increased  purchases.  But  in  the  long  run  the  increase  or 
decrease  of  the  total  volume  of  trade  must  depend  upon  the 
natural  resources  of  the  country,  the  productive  energies  of  the 
people,  and  the  degree  to  which  division  of  labor  has  been 
achieved.  It  can  have  no  permanent  dependence  upon  the 
amount  of  money  in  circulation.  In  the  second  place,  a  sud- 
den increase  in  the  supply  of  money  is  likely  to  bring  about  a 
temporary  decrease  in  V,  its  velocity  of  circulation,  because  a 
larger  amount  of  money  may,  for  the  time  being,  be  kept  idle. 
But,  with  a  given  volume  of  transactions  at  given  prices,  V 
must  in  the  long  run  depend  very  largely  upon  the  habits  of 
the  people  with  respect  to  the  amount  of  "  pocket  money  " 
usually  kept  on  hand.  Changes  in  habits  of  this  kind  are 
slow,  and  may  safely  be  neglected  in  studying  the  movement 
of  prices  through  even  a  considerable  number  of  years. 

When,  in  the  third  place,  we  come  to  consider  the  effect  of  an 
increase  in  M  upon  the  magnitude  of  M',  the  amount  of  bank 
deposits  subject  to  check,  we  find  that  these  two  things  are 
necessarily  connected.  For  an  increase  in  M,  the  amount  of 
money  in  circulation,  -  is  very  sure  to  be  accompanied  by  an 
increase  in  bank  reserves.  Additions  to  the  country's  stock  of 
money  will  distribute  themselves,  ultimately,  between  bank 
reserves  and  hand-to-hand  circulation,  and  the  proportions  of 
the  country's  monetary  stock  allotted  to  these  two  uses  usually 
fluctuate  only  between  more  or  less  definite,  even  if  gradually 
changing,  limits.  But  an  increase  in  bank  reserves  normally 
brings  with  it  an  increase  on  M' ,  the  amount  of  bank  deposits 
subject  to  check.  Even  in  the  absence  of  minimum  reserve 
laws,  the  ratio  of  aggregate  bank  reserves  to  aggregate  bank 
deposits  is  found,  for  the  time  being,  to  fluctuate  around  an 
approximately  constant  proportion.  An  increase  in  M,  there- 
fore, is  very  sure  to  result  in  an  increase  in  M'. 

It  follows,  then,  that  despite  a  certain  amount  of  variability 
in  the  other  factors  in  the  equation  of  exchange,  an  increase  in 


324  OUTLINES  OF  ECONOMICS 

M,  carrying  with  it  a  roughly  proportionate  increase  in  M\ 
must  normally  have  as  its  most  important  concomitant  a 
similar  general  increase  in  prices.  This,  it  will  be  noted,  is  in 
harmony  with  the  conclusion  we  had  already  reached  without 
the  aid  of  the  equation  of  exchange.  But  that  conclusion  was 
stated  in  terms  of  the  "  amount  of  money  (and  credit  instru- 
ments) exchanged  for  goods  and  services,"  the  volume  of  trade 
being  constant.  We  now  see  that  a  similar  conclusion  holds 
true  when  stated  in  terms  of  the  quantity  of  money  in  circula- 
tion, the  only  qualifying  factors  being  probable  changes  of 
greater  or  less  importance  in  (i)  the  rate  of  turnover  of  money, 
(2)  the  ratio  of  the  amount  of  money  in  bank  reserves  to  the 
total  amount  of  money  in  circulation,  (3)  the  ratio  of  bank 
reserves  to  bank  deposits,  and  (4)  the  rate  of  turnover  of  bank 
deposits.  Allowing  for  the  influence  of  these  qualifying  factors, 
an  increase  or  decrease  in  the  quantity  of  money,  the  volume  of 
trade  being  constant,  must  be  accompanied  by  a  proportionate 
general  increase  or  decrease  in  prices.  This  principle,  known 
as  "  the  quantity  theory  of  prices,"  has  long  been  one  of  the 
most  important  theorems  of  economics.1 

General  changes  in  prices  must,  of  course,  accompany  changes  in  any  of 
the  factors  in  the  equations  of  exchange,  unless  these  happen  to  counteract 
one  another.  If  the  volume  of  trade  increases  more  rapidly  than  the  supply 
of  money,  and  other  things  remain  equal,  prices  must  decrease.  This  is 
the  apparent  explanation  of  the  general  fall  in  prices  between  1873  and  1897. 
The  growing  use  of  checks  in  making  payments  is  substantially  like  an 
increase  in  the  supply  of  money.  It  increases  the  ratio  of  money  in  bank 
reserves  to  money  in  hand-to-hand  circulation,  and  thereby  increases  the 
ratio  of  M '  to  M.    Unless  offset  by  changes  in  other  factors,  this  must  be 

1  Professor  Irving  Fisher,  by  making  skillful  use  of  such  statistics  as  are  available, 
has  estimated  the  magnitude  of  the  various  items  in  the  equation  of  exchange  for 
each  year  since  1896.  For  one  factor,  the  total  volume  of  trade,  Professor  Fisher 
had  to  be  content  with  relative  figures,  showing  merely  the  estimated  percentage 
changes  in  the  volume  of  trade  from  year  to  year.  By  using  merely  his  figures  for 
M,  V,  M',  V,  and  T,  Professor  Fisher  was  able  to  get  values  showing  the  relative 
year-by-year  changes  in  P  which  agreed  very  closely  with  figures  derived  from 
the  statistics  of  actual  price  movements.  Similar  estimates,  based  on  somewhat 
less  complete  statistics,  had  previously  been  made  by  Professor  E.  W.  Kemmercr. 
See  Fisher,  The  Purchasing  Power  of  Money;  and  Kemmercr,  Money  and  Credit 
Instruments  in  their  Relations  to  General  Prices. 


OTHER  PROBLEMS   IN  MONEY  AND   BANKING       325 

accompanied  by  rising  prices.  An  improvement  in  the  organization  of  the 
banking  system,  making  possible  a  smaller  normal  ratio  of  aggregate  bank 
reserves  to  aggregate  bank  deposits  must  also  tend  to  increase  prices. 
Along  with  a  phenomenal  increase  in  the  quantity  of  money  in  the  past 
twenty  years  there  has  been,  in  fact,  a  large  increase  in  both  the  ratio  of 
deposits  to  money  and  in  the  rate  of  turnover  of  deposits. 

The  Mechanism  of  General  Changes  in  Prices.  —  Thus  far 
we  have  considered  only  the  mathematically  necessary  relations 
between  changes  in  the  quantity  of  money  and  general  changes 
in  prices.  The  quantity  theory  of  prices,  even  when  stated  in 
the  form  of  the  equation  of  exchange,  tells  us  nothing  about  the 
process  of  general  price  changes ;  nothing,  that  is,  about  the 
mechanism  by  which  a  change  in  the  quantity  of  money  oper- 
ates to  bring  about  general  changes  in  prices.  No  one  has  ever 
given  a  complete  description  or  analysis  of  this  process,  and 
doubtless  no  one  description  would  fit  all  instances  of  general 
price  changes  brought  about  by  changes  in  the  quantity  of 
money.     But  some  aspects  of  the  matter  are  tolerably  clear. 

Take  an  artificially  simple  case.  Imagine  an  isolated  com- 
munity with  no  foreign  trade  and  with  no  banks.  Suppose 
that  a  group  of  men  find  a  long-forgotten  hoard  of  gold,  large 
even  as  compared  with  the  existing  stock  of  gold  in  circulation. 
Without  increasing  their  own  activities  as  producers  the  finders 
are  now  able  to  purchase  larger  quantities  of  goods.  These 
additional  purchases,  it  is  important  to  note,  are  the  direct 
result  of  the  increase  in  the  supply  of  money,  and  could  not  have 
been  made  without  it.  The  merchants  into  whose  hands  the 
money  comes  in  turn  expend  it  to  replenish  their  stocks  and  for 
other  purposes.  And  so  the  money  passes  from  hand  to  hand, 
increasing  the  number  of  exchanges  —  the  volume  of  trade  — ■ 
just  about  proportionately  to  the  increase  in  money. 

But  this  increase  in  the  volume  of  trade  cannot  be  the  end 
of  the  process.  More  goods  than  before  are  passing  into  the 
possession  of  their  ultimate  consumers.  The  country's  stock 
of  exchangeable  goods  is  being  depleted  more  rapidly  than  it 
can  be  replenished  out  of  the  country's  normal  agricultural  and 
industrial  output.     In  short,  the  purchasing  power  of  the  com- 


326  OUTLINES  OF  ECONOMICS 

munity,  at  the  old  level  of  prices,  is  now  more  than  sufficient  to 
buy  the  current  output.  Under  the  pressure  of  competing 
purchasers,  desiring  to  exchange  money  for  goods,  prices  will 
rise.  And  if  the  industrial  output  cannot  be  permanently  in- 
creased the  rise  in  prices  will  be  proportionate  to  the  increase 
in  the  money  supply,  so  that  finally  the  larger  supply  of  money 
will  have  brought  with  it  no  permanent  increase  in  the  number 
of  exchanges. 

The  conditions  under  which  general  price  changes  resulting 
from  an  increase  in  the  quantity  of  money  occur  in  actual  life 
are  much  more  complex,  and  yet  there  is  no  reason  to  suppose 
that  in  its  fundamentals  the  process  is  essentially  unlike  that 
which  we  have  just  outlined.  There  is,  however,  the  difference 
that  additions  to  the  supply  of  money  usually  find  their  way  at 
first  into  bank  reserves,  where  their  immediate  effect  is  to  lower 
the  discount  rate.  This  leads  to  increased  bank  lending  and 
to  larger  bank  deposits,  and  the  immediate  purchasing  power 
of  the  community,  in  the  form  of  its  power  to  draw  bank  checks, 
is  correspondingly  increased.  Increased  purchases  will  be 
made,  and  so  far  as  the  immediate  effect  upon  prices  is  con- 
cerned, it  is  immaterial  that  a  large  part  of  the  increase  may  be 
in  purchases  of  labor,  raw  materials,  and  supplies,  i.e.  in  expen- 
ditures for  "  productive  '  rather  than  for  "  final  "  consump- 
tion. Prices  must  rise,  and  this  will  draw  a  larger  amount  of 
money  into  hand-to-hand  circulation.  With  higher  prices 
people  will  find  it  convenient  to  keep  somewhat  larger  amounts 
of  money  on  hand  as  "  pocket-money."  Finally,  unless  new 
disturbing  factors  appear,  equilibrium  will  be  reached  between 
the  amount  of  money  in  bank  reserves  and  the  amount  of  money 
in  hand-to-hand  circulation.  It  seems  probable,  then,  that 
the  sequence  of  processes  by  which  an  increase  in  the  supply  of 
money  actually  brings  about  a  general  increase  in  prices  may 
often  be  (i)  larger  bank  reserves,  (2)  lower  discount  rates, 
(3)  larger  bank  deposits,  (4)  more  purchases,  (5)  higher  prices, 
(6)  more  money  drawn  into  hand-to-hand  circulation.  Prices 
get  their  initial  upward  impetus  from  the  larger  bank  re- 
serves, but  the  increase  in  the  amount  of  money  in  hand-to- 


OTHER   PROBLEMS   IN  MONEY  AND   BANKING       327 

hand  circulation    helps  to   support  and   maintain    the   higher 
price-level.1 

Thus  far,  however,  we  have  neglected  to  take  account  of  the 
very  important  facts,  (1)  that  gold  has  other  than  monetary 
uses,  (2)  that  the  production  of  gold  will  itself  depend  in  part 
upon  its  purchasing  power,  and  (3)  that  international  gold  ship- 
ments are  also  partly  dependent  upon  the  relative  purchasing 
power  of  money  in  one  country  and  another.  Leaving  the  last 
of  these  three  topics  for  treatment  in  the  following  chapter  in 
connection  with  the  general  subject  of  international  trade,  we 
pass  now  to  the  discussion  of  the  other  two. 

The  Relation  of  the  Industrial  Uses  of  Gold  to  Prices.  — 
From  the  estimates  of  the  Director  of  the  Mint  it  appears  that 
in  recent  years  from  one  fourth  to  one  third  of  the  world's 
annual  production  of  gold  finds  its  way  into  industrial  uses. 
The  United  States  mints  and  assay  offices  refine  nearly  all  the 
crude  gold  bullion  produced  in  or  brought  to  this  country, 
and  allow  the  depositor  to  take  the  proceeds  in  money  or  in 
bars  of  gold  for  industrial  use,  as  he  prefers.  But  even  without 
this  convenient  arrangement  there  would  be  a  constant  balanc 
ing  or  comparison  of  the  relative  advantages  of  the  industric 
and  monetary  uses  of  gold.  The  number  of  dollars  which  car. 
be  got  by  selling  gold  for  money  and  by  actually  converting 
gold  into  money  must,  of  course,  always  be  approximately 
equal. 

More  than  that,  there  are  two  things  quite  distinct  from 
the  direct  process  of  selling  gold  bullion  for  money  which  help  to 
fix  the  ratios  of  exchange  between  gold  and  other  things.  Con- 
sumers, on  the  one  hand,  are  constantly  weighing  the  marginal 
utility  of  objects  made  from  gold  against  the  marginal  utility 
of  other  things.  Producers,  on  the  other  hand,  are  weighing 
the  relative  profitableness  of  producing  things  made  from  gold 
and  things  made  from  other  materials.  It  is  clear  that  gold  will 
be  distributed  between  its  industrial  and  monetary  uses  in  such 
a  way  as  to  equalize  the  exchange  ratios  of  gold  and  other 

1  Cf.  the  testimony  of  Professor  Alfred  Marshall  before  the  British  Gold  and 
Silver  Commission  of  1888,  in  Appendix  to  Final  Report,  p.  3. 


328  OUTLINES- OF  ECONOMICS 

things  for  the  two  uses.1  If,  for  example,  an  increase  in  the 
stock  of  money  (whether  gold  or  not)  results  in  increased  prices 
(i.e.  in  decreased  purchasing  values  of  gold),  a  relatively  larger 
amount  of  the  gold  annually  brought  to  the  mints  will  tend 
to  flow  into  industrial  uses,  and  thus  to  limit  the  increase  in  the 
amount  of  money  and  the  consequent  rise  in  prices. 

The  Relation  of  the  Expenses  of  Gold  Production  to  Prices.  — 
There  is  another  way  in  which  society  makes  direct  compari- 
sons between  the  value  of  gold  and  the  value  of  other  things. 
Mining,  like  agriculture,  is  subject  to  the  law  of  increasing 
expenses,  and  the  tendencies  of  prices  to  equal  the  maximum 
expenses  of  production  per  unit  holds  true  for  both  indus- 
tries. Not  only  are  there  marginal  mines,  mines  which  it  just 
pays  to  operate,  but  in  the  most  productive  mines  there  are 
margins,  —  certain  depths,  for  example,  beyond  which  the 
expense  of  mining  more  than  eats  up  the  value  of  the  product. 
Through  the  operators  of  mines,  society  is  continually  compar- 
ing the  cost  in  labor  and  capital  of  the  production  of  gold  with 
the  cost,  similarly  measured,  of  the  things  that  can  be  bought 
with  the  produced  gold.  If  the  gold  produced  at  the  margin 
will  purchase  things  which  consumers  deem  of  less  importance 
than  other  things  which  might  have  been  produced  with  the 
use  of  no  more  capital  and  labor,  capital  and  labor  will  grad- 
ually be  shifted  from  their  marginal  use  in  gold  mining  to  the 
production  of  other  things.  Here,  then,  as  in  the  case  of  the 
balancing  between  the  monetary  and  industrial  uses  of  gold, 
we  have  a  direct  value-comparison  of  gold  and  other  things. 

Some  years  ago  the  Bureau  of  the  Mint  undertook  an  investi- 
gation into  the  relation  of  the  expense  of  gold  mining  to  the 
amount  of  gold  produced.  The  conclusion  reached  is  worth 
quoting  in  this  connection : 

In  every  mining  district  there  are  mines  producing  at  good  profits,  mines 
producing  at  small  profits,  mines  barely  paying  expenses,  and  Miines  oper- 
ated at  a  loss,  but  with  the  hope  that  they  will  do  better.  Every  increase 
in  costs  would  submerge  the  latter  more  deeply,  add  to  the  list  of  the  un- 

1  The  expense  of  transforming  bullion  into  jewelry,  etc.,  is  left  out  of  account 
as  it  does  not  affect  the  principle  under  consideration. 


OTHER   PROBLEMS   IN  MONEY  AND   BANKING       329 

profitable,  and  probably  close  some  of  them.  ...  A  higher  scale  of  work- 
ing costs  will  bring  losing  experiments  to  an  earlier  conclusion,  reduce  profits, 
and  make  mining  ventures  generally  less  attractive,  and  thus  diminish  the 
output.1 

To  summarize  :  Marginal  utilities  and  subjective  values  are 
found  in  the  industrial  uses  of  gold.  The  particular  form  of  the 
law  of  normal  price  that  is  operative  in  agriculture  also  holds 
true  in  gold  mining  (although  it  has  to  be  stated  in  a  somewhat 
different  way).  An  increase  in  the  supply  of  gold  diminishes  its 
marginal  utility  in  industrial  uses.  This  is  bound  to  decrease 
the  values  of  gold  as  money,  on  account  of  the  ease  with  which 
the  supply  of  gold  can  be  shifted  to  one  use  or  the  other.  Such 
a  rise  of  prices,  however,  cannot  continue  indefinitely.  The 
increase  of  prices  and  wages  brings  increasing  expenses  in 
gold  mining,  and,  unless  new  gold  mines  are  found  or  cheaper 
ways  of  getting  gold  from  old  mines  are  invented,  the  output 
of  gold  will  have  to  decrease. 

These  things  have  a  steadying  influence  upon  prices.  Tend- 
encies toward  extreme  fluctuations  in  prices  are  held  in  check 
by  the  resulting  changes  in  the  expense  of  mining  gold  and  by 
the  automatic  changes  in  the  proportions  of  the  annual  gold 
product  that  flow  into  monetary  circulation  and  into  industrial 
uses.  It  is  in  these  ways  that  the  significance  of  the  fact  that 
the  monetary  standard  is  itself  a  commodity  appears. 

The  Increase  in  the  Production  of  Gold.  —  Although  prob- 
ably more  gold  was  produced  between  1850  and  1875  than  from 
1492  to  1850,  yet,  as  Table  I  shows,  the  annual  production  of 
gold  since  1896  has  been  from  two  to  three  times  as  large  as  it 
was  between  1850  and  1875.  Most  of  this  great  output  of  gold, 
as  Table  II  indicates,  comes  from  relatively  few  countries. 
At  present  the  British  empire  supplies  over  one  half  and  the 
United  States  (including  Alaska)  nearly  one  fourth  of  the  total 
product.  The  causes  of  this  enormous  increase  were,  in  part, 
the  opening  up  of  new  gold  fields  in  South  Africa,  Canada, 
Alaska,  and  Colorado,  and  in  part  the  improvements  in  methods 
of  extracting  gold  from  low  grade  and  refractory  ores,  in  which 

1  Report  on  the  Production  of  the  Precious  Metals,  1004,  p.  41. 


33° 


OUTLINES  OF  ECONOMICS 


TABLE  I 
Production  of  Gold  in  the  World  since  1841 

(From  1 841  to  1885  the  estimate  is  from  a  table  of  averages  for  certain  periods, 
compiled  by  Dr.  Adolph  Soetbeer;  for  the  years  1886  to  191 2  the  production  is  the 
annual  estimate  of  the  Bureau  of  the  Mint.) 


Annual  Average  for  Period 

Period 

Fine  Ounces                                      Value 

1841-1850 

1,760,502 

$  36,393,000 

1851-1855 

6.410,324 

132,513,000 

1856-1860 

6,486,262 

134,083,000 

1861-1865 

5,949,582 

122,989,000 

1866-1870 

6,270,086 

129,614,000 

1871-1875 

S.SWPH 

115,577,000 

1876-1880 

5,543,"° 

114,586,000 

i8Si-;8S5 

4-794,755 

99,116,000 

1886-.S90 

5,461,282 

ii2,S95,ooo 

1S91-1895 

7,882,565 

162,947,000 

1 896-; 900 

12,446,939 

257,301,100 

1 901-1905 

15,603,730 

322,619,800 

1906-T910 

20,971,575 

433,520,900 

1911 

22,348,313 

461,939,700 

1912 

22,549,335 

466,136,100 

TABLE   II 
Recent  Production  of  Gold  in  Different  Countries' 


Country 

Africa 

Australia 

United  States  and  Alaska 

Russia 

Canada  

British  India    .... 

Mexico 

China 

All  others 

Total 


1897 


97 
86 

35 

9 

12 

11 

9 
26 


355 


1900 


385 


1904 


13 

129 

III 

132 

119 

121 

31 

37 

42 

25 

14 

18 

13 

19 

8 

7 

35 

35 

523 


1  From  Journal  of  Folitical  Economy,  vol.  x.  p.  580,  and  Finance  Report,  1907, 
p.  ,363.    The  figures  are  given  in  thousands  of  kilograms. 


OTHER   PROBLEMS   IN  MONEY  AND   BANKING       331 

connection  the  development  of  the  "  cyanide  process "  has 
been  of  special  importance.1  Dredging  for  gold  in  the  beds  of 
rivers  which  drain  gold-yielding  lands,  is  a  very  recent  devel- 
opment of  considerable  importance.  Notwithstanding  the  de- 
crease in  the  value  of  gold,  the  bulk  of  the  gold  produced  in 
California  today  is  from  ore  bodies  that  twenty-five  or  thirty 
years  ago  were  generally  considered  worthless. 

The  effects  of  this  enormous  output  have  been  felt  in  both 
Europe  and  America  in  a  general  increase  of  both  prices  and 
wages.  There  are  some  who  expect  that  the  values  of  gold  will 
continue  to  depreciate  for  a  long  time  in  the  future.  Account 
must  be  taken,  however,  of  the  automatic  check  which  the 
increase  in  wages  and  prices  is  bound  to  put  on  the  production 
of  gold  by  increasing  mining  expenses.  On  the  other  hand, 
still  further  economies  in  productive  methods  are  possible. 

Some  Economic  Effects  of  Changes  in  the  Values  of  Money. 
—  We  have  seen  that  an  increase  in  the  amount  of  money 
available  for  bank  reserves  leads  to  the  expansion  of  credit, 
stimulates  business,  and  increases  prices.  The  same  results 
are  achieved,  although  not  in  the  same  way,  by  a  sudden  debase- 
ment of  the  standard  of  value,  or  by  the  introduction  of  irre- 
deemable paper  money  as  the  medium  of  exchange.  Prices 
are  gradually  increased  under  such  conditions,  there  being  an 
unmistakable  tendency  to  adjust  them  to  the  change  in  the 
"  dollar  "  or  other  unit  of  the  medium  of  exchange.2  The 
rising  prices  stimulate  business  by  increasing  profits.     Profits 

1  "There  are  many  mines  in  operation  now  at  a  profit  which  could  not  have  been 
worked  at  a  profit  ten  years  ago.  There  has  been  an  important  addition  to  the 
gold  and  silver  product  by  the  recovery  of  these  metals  from  lead  and  copper  ores 
by  modern  processes.  The  most  important  gains  seem  to  have  come,  however, 
through  economies  in  management,  particularly  by  enlarging  the  scale  of  operations 
and  by  more  complete  extraction  of  the  values  from  the  ores  treated."  — ■  Report  on 
the  Production  of  the  Precious  Metals,  1904,  p.  41. 

2  Possibly  the  effect  upon  other  prices  of  the  increased  prices  (measured  in  the 
depreciated  money)  that  have  to  be  paid  for  imported  commodities  and  that  are 
received  for  exported  commodities  is  the  key  to  this  problem,  just  as  it  was  undoubt- 
edly the  chief  cause  of  the  rise  of  prices  to  fit  the  bullion  value  of  coins  from  which 
seigniorage  had  been  taken.  This  is  the  explanation  of  the  rise  of  prices  under 
the  greenbacks  suggested  by  Professor  W.  C.  Mitchell,  the  historian  of  that  move- 
ment. 


332  OUTLINES  OF  ECONOMICS 

are  increased  because  most  of  the  expenses  of  production  are 
incurred  before  the  goods  are  sold,  so  that  the  rise  in  prices 
increases  the  margin  between  prices  and  the  expenses  of  pro- 
duction, and  because,  moreover,  some  of  the  expenses  of  pro- 
duction do  not  usually  rise  as  rapidly  as  do  prices.  An  expan- 
sion of  business  activity  of  the  kind  already  described  is  apt  to 
be  the  result,  and  this  is  not  generally  soon  restrained  by  in- 
sufficient bank  reserves,  for  depreciated  money  is  usually, 
though  not  always,  money  that  is  coined  or  issued  in  large 
quantities. 

That  periods  of  prosperity  induced  in  this  way  are  inevitably 
short-lived  and  usually  end  in  severe  crises  does  not  make  them 
any  the  less  real.  Nor  should  the  fact  that  such  artificial  condi- 
tions of  business  enterprise  are  apt  to  be  accompanied  by  exces- 
sive speculation  and  other  unhealthy  features  blind  us  to  the 
fact  that  they  accomplish  some  good.  The  encouragement 
given  to  venturesome  undertakings  leads  to  the  trial  of  new 
methods  of  production,  to  the  development  of  new  natural 
resources,  to  undertakings  of  vast  proportion,  to  a  general  free- 
ing of  industrial  organization  and  methods  from  the  restraints 
of  habit  and  tradition.  The  foundations  of  modern  large-scale 
industry  in  the  United  States  were  laid  in  the  period  between 
the  Civil  War  and  the  panic  of  1873.  The  period  of  state  bank 
note  inflation  preceding  the  panic  of  1837  was  a  period  in  which 
the  industrial  map  of  the  United  States  was  almost  wholly 
changed,  and,  in  the  long  run,  for  the  better. 

A  rapid  increase  in  the  supply  of  standard  money  may  have  a 
similar  effect.  A  tremendous  expansion  of  international  trade 
followed  the  gold  discoveries  in  California  and  Australia.  In 
the  sixteenth  century,  increases  in  the  supply  of  the  money 
metals,  historians  are  agreed,  hastened  the  fall  of  the  medieval 
economic  system.  The  almost  unparalleled  development  of 
industry  and  industrial  organization  in  the  United  States  since 
1897  must,  with  its  good  features  as  well  as  its  bad,  be  at- 
tributed in  part  to  the  increased  supply  of  gold. 

Business  prosperity,  however,  does  not  always  coincide  with 
the  real  economic  welfare  of  the  masses  of  the  people.     If 


OTHER   PROBLEMS   IN   MONEY  AND   BANKING       333 

prices  are  rising  faster  than  money  wages,  real  wages  are  ob- 
viously declining.  A  period  of  falling  prices  is  very  apt  to  be 
ii  period  of  increasing  well-being  for  those  whose  incomes  are 
wages  or  salaries,  although  here  we  have  to  remember  that 
even  if  daily  or  weekly  wages  do  not  fall  so  rapidly  as  prices, 
an  increase  of  unemployment  may  affect  total  yearly  incomes 
adversely. 

Crises.  —  Crises  are  frequently  recurring  phenomena  of  cur- 
rent economic  life.  They  are  of  all  degrees  of  severity,  but 
are  generally  characterized  by  a  scarcity  of  bank  credit,  a 
sudden  drop  in  prices,  a  subsequent  period  of  industrial  depres- 
sion, lack  of  employment  for  wage  earners,  and  kindred  symp- 
toms. 

Crises  are  frequently  attributed  to  "  over  production,"  or, 
when  that  expression  is  criticized  (because  human  wants  are 
never  fully  satisfied)  to  "  under  consumption."  The  two  ex- 
pressions are  different  ways  of  describing  the  same  thing,  and 
both  are  misleading  because  they  put  the  emphasis  in  the  wrong 
place.  Production  and  consumption  have  to  do  with  quanti- 
ties of  things  and  their  fitness  to  satisfy  human  wants.  Crises 
spring  from  mishaps  in  the  price  process ;  they  relate  to  what 
might  be  called  the  dollars  and  cents  aspect  of  economic  life. 
It  is  difficult,  even  impossible,  for  observers  to  analyze  all  the 
factors  entering  into  a  particular  crisis,  and  it  is  even  more 
difficult  to  formulate  a  theory  of  crises  that  will  be  of  general 
applicability.  There  are  some  important  things  about  crises, 
however,  that  are  relatively  well  known,  and  these  will  form 
the  basis  of  our  discussion. 

It  is  a  significant  fact  that  crises  generally  occur  only  as  sharp 
interruptions  of  periods  of  business  prosperity,  when  credit  is 
abundant,  prices  relatively  high,  and  employment  plentiful. 
Whatever  may  be  the  cause  of  a  period,  of  exceptional  business 
prosperity,  it  is  apt  to  contain  within  itself  the  seeds  of  its  own 
destruction.  The  point  will  appear  clearly  if  we  put  together 
two  conclusions  that  were  reached  in  the  preceding  chanter : 
first,  that  the  supply  of  loanable  funds  in  the  form  of  bank 
credit  is  a  function  of  two  variables,  —  the  supply  of  personal 


334  OUTLINES   OF  ECONOMICS 

credit  and  the  supply  of  money  available  for  bank  reserves; 
second,  that  personal  credit  is  based  on  the  probable  amount 
of  future  money  incomes  and  probable  future  prices  of  property. 
Suppose,  for  example,  that  business  conditions  are  pros- 
perous and  promise  to  continue  so,  and  that  there  is  a  plentiful 
supply  of  money  in  the  bank  reserves.  Expected  prices  and 
expected  profits  are  large,  expected  interest  payments  seem 
certain.  The  power  to  get  this  future  income  depends,  how- 
ever, upon  the  possession  of  land,  capital  goods,  franchises  and 
other  privileges,  the  established  business  relations  that  give 
rise  to  "  good-will  values,"  or  upon  the  possession  of  income- 
yielding  securities,  such  as  mortgages,  bonds,  stocks,  etc. 
Under  such  conditions,  these  things  command  good  prices  in 
the  market  and  may  easily  be  hypothecated,  either  formally  or 
implicitly,  in  order  to  secure  purchasing  power,  —  bank  credit. 
The  bank  credit  thus  created  is  put  into  further  investments 
of  capital  and  into  the  creation  of  further  business  opportunities. 
These  things  serve  in  turn,  so  long  as  their  income-yielding 
power  seems  certain,  as  the  basis  of  further  extensions  of  bank 
credit,  and  thus  the  process  of  business  expansion  continues 
in  a  cumulative  fashion.  Overproduction,  it  is  true,  is  present, 
but  it  is  the  overproduction  of  the  means  of  production  and  of 
acquisition,  —  of  railways,  factories,  and  business  schemes,  — 
and  it  is  accompanied  by  the  overappraisal,  the  overcapitaliza- 
tion, of  these  things.  An  extensive  period  of  increasing  pros- 
perity of  -this  kind  is,  however,  scarcely  possible  unless  the 
supply  of  money  is  increasing ;  for  bank  reserves  as  well  as  the 
amount  of  expected  personal  incomes  condition  the  supply  of 
purchasing  power.  Very  often,  in  fact,  it  may  be  a  sudden 
increase  in  the  supply  of  money  available  for  bank  reserves  that 
gives  the  initial  impetus  to  the  rapid  expansion  of  business. 
Larger  reserves,  lower .  discount  rates,  larger  investments,  an 
increased  volume  of  trade,  is  as  we  have  seen,  the  normal 
sequence  in  such  cases.  Periods  of  rising  prices  are  periods  of 
rising  profits,  for  fixed  charges,  the  rate  of  interest  (even  on 
new  borrowings),  and  wages  do  not  usually  rise  as  rapidly  as 
prices.    These  rising  profits  are,  of  course,  the  direct  cause  of 


OTHER   PROBLEMS   IN  MONEY   AND   BANKING       335 

the  overinvestment  in  production  goods  and  the  overcapitaliza- 
tion of  business  opportunities. 

Any  one  of  a  number  of  things  may  be  sufficient  to  precipitate 
a  panic  under  such  conditions.  The  whole  business  structure 
may  fall  to  pieces  through  sheer  topheaviness.  That  is,  so  much 
production  today  is  indirect,  so  large  a  share  of  productive 
effort  is  devoted  to  forwarding  in  indirect  ways  the  production 
of  goods  that  will  be  ripe  for  human  use  only  in  the  compara- 
tively distant  future,  that  the  mere  operations  of  supply  and 
demand  among  business  men  themselves  may  maintain  pros- 
perous business  conditions  for  some  time.  But  in  the  long  run 
the  maintenance  of  the  values  of  producer's  goods  and  privi- 
leges depends  on  the  demand,  and  hence  on  the  income,  of 
ultimate  consumers.  Wages  do  not  usually  rise  as  rapidly  as 
prices  in  periods  of  business  expansion.  This  simple  fact  may 
in  itself  keep  the  average  purchasing  power  of  consumers 
from  expanding  rapidly  enough  to  furnish  a  solid  support  for  the 
growing  structure  of  capital  values. 

Crop  failures  may  precipitate  a  panic  by  diminishing  the  pur- 
chasing power  of  those  engaged  in  agriculture,  and,  possibly,  by 
reducing  exports  and  thus  necessitating  the  taking  of  gold  from 
the  bank  reserves  to  ship  to  Europe  in  payment  for  our  imports. 
When  the  credit  situation  is  at  all  strained,  the  failure  of  one  im- 
portant bank  may  be  enough  to  precipitate  a  panic.  The  bank's 
creditors  are  prevented  from  meeting  their  own  obligations ; 
the  solvency  of  others  is  in  turn  dependent  upon  them,  and  thus 
losses  in  expected  and  often  already  hypothecated  income  are 
transmitted  from  firm  to  firm  and  from  industry  to  industry 
in  a  constantly  widening  circle.  The  reduction  of  bank  re- 
serves by  reason  of  the  flow  of  money  into  hand-to-hand  cir- 
culation in  order  to  effect  exchanges  at  the  higher  level  of  prices 
may  itself  be  a  contributing  cause  of  a  panic. 

In  fact,  whatever  may  be  the  immediate  cause  of  a  panic,  it  is 
bound  to  grow,  in  a  condition  of  inflated  capital  values,  with 
tremendous  rapidity.  The  collapse  of  credit  leads  to  forced 
sales  of  property  in  order  that  credit  obligations  may  be  met. 
These  reduce  prices,  lessen  the  security  on  which  credit  is 


336  OUTLINES  OF  ECONOMICS 

founded,  and  render  banks  less  able  and  less  willing  to  make 
loans.  Moreover,  the  hoarding  of  money,  which  is  apt  to  be  a 
feature  of  a  panic,  has  a  destructive  effect  on  bank  reserves.  In 
a  serious  panic  the  liquidation  of  obligations  has  to  work  itself 
out.  Then  the  industrial  process  starts  afresh,  with  lowered 
values  imputed  to  capital  goods  and  to  business  opportunities, 
and  with  property  rights  shifted,  in  some  measure,  to  creditors. 

Crises  seem  to  be  unpreventable  so  long  as  competition  and 
the  credit  system  dominate  in  industry.  Yet  there  are  some 
recent  developments  that  may  make  them  less  frequent,  and 
possibly  less  serious. 

The  "  integration  of  industry,"  whereby  a  whole  series  of  pro- 
ductive processes,  from  the  production  of  the  raw  material  to  the 
sale  of  the  finished  product,  are  brought  together  under  one 
management,  decreases  the  number  and  complexity  of  credit 
relations  between  producers,  and  tends  to  prevent  the  undue 
expansion  of  those  parts  of  the  productive  process  that  are 
farthest  removed  from  the  consumer.  The  strong  position  of 
the  steel  industry  in  the  United  States  is  a  case  in  point.  The 
improvements  in  the  bargaining  power  of  wage  earners  result- 
ing from  their  organization  have  enabled  them  partly  to  pre- 
vent the  widening  of  the  gap  between  wages  and  prices  in  pros- 
perous times,  as  recent  American  statistics  show.  On  the 
other  hand,  crop  failures  are  and  always  will  be  a  factor  of 
uncertainty.  The  best  way  of  softening  the  rigors  of  a  panic 
and  of  restoring  normal  conditions  promptly  is  through  a  wise 
use  of  the  lending  power  inherent  in  a  system  of  really  elastic 
bank  reserves,  just  as  the  best  way  of  preventing  panics  is 
through  a  firm  control  of  discount  rates  when  all  other  condi- 
tions are  ripe  for  a  period  of  business  inflation.  It  is  in  these 
ways,  perhaps,  that  the  new  federal  reserve  system  can  best 
serve  the  country. 

The  Standard  of  Deferred  Payments.  —  The  relation  of 
changes  in  the  purchasing  power  of  money  to  long-time  debts 
and  credits  has  some  very  important  aspects.  If  prices  increase, 
the  principal  of  a  loan  represents  less  purchasing  power  at  the  time 
of  repayment  than  at  the  time  the  loan  was  made.     If  prices 


OTHER   PROBLEMS   IN   MONEY  AND   BANKING       337 

decrease,  the  reverse  is,  of  course,  true.  In  periods  of  cheap 
money  agitations  the  additional  burdens  imposed  upon  debtors 
in  a  period  of  decreasing  prices  are  emphasized.  An  important 
function  of  money,  then,  is  found  in  its  use  as  a  standard  of 
deferred  payments. 

There  is  a  partial,  but  only  partial,  compensation  for  the  in- 
justice to  debtors  and  creditors  resulting  from  general  changes 
in  prices  in  the  fact  that  the  interest  rate  usually  increases 
when  prices  increase  and  decreases  when  prices  decrease.  This 
is  largely  because  rising  prices  increase  profits,  thus  inducing 
business  men  to  pay  higher  interest  rates  in  order  to  secure  larger 
supplies  of  funds  for  investment;  while  falling  prices  decrease 
profits  and  lessen  the  demand  for  loanable  funds.  The  result 
of  this  is  that  the  changing  purchasing  power  of  the  principal 
of  a  loan  is  to  some  extent  offset  or  discounted  by  changes  in 
the  rate  of  interest.  The  decline  in  interest  rates  as  prices  fall 
makes  it  possible  for  debtors  to  pay  off  their  old  obligations  with 
funds  borrowed  at  a  lower  rate  of  interest.  Creditors  cannot 
so  easily  take  advantage  of  the  fact  that  interest  rates  are  in- 
creasing when  the  purchasing  power  of  the  principal  of  their 
outstanding  loans  is  decreasing.  Nevertheless,  more  emphasis 
has  been  given  to  the  question  of  the  standard  of  deferred  pay- 
ments in  periods  of  declining  prices,  when  debtors  are  in- 
juriously affected,  than  in  periods  of  rising  prices,  when  credi- 
tors are  the  losers.  The  United  States  is  rapidly  ceasing  to  be 
a  "  debtor  nation,"  and  the  farmers,  in  particular,  are  becom- 
ing less  distinctively  a  "  debtor  class."  We  may  expect, 
therefore,  that  in  a  future  period  of  declining  prices  we  shall 
hear  less  about  the  injustice  of  our  variable  standard  of  deferred 
payments. 

Index  Numbers.  —  General  changes  in  prices  are  indicated 
statistically  by  the  use  of  index  numbers.  An  index  number, 
in  the  most  general  sense,  is  some  magnitude  which  varies  with 
some  other  magnitude  or  complex  of  magnitudes,  and  whose 
variations  can  therefore  be  taken  as  representing  or  indicating 
the  other  variations.  In  studying  the  variations  of  the  price 
of  some  specific  thing  we  need  no  index  number ;  but  when  we 


338  OUTLINES  OF  ECONOMICS 

have  to  deal  with  the  variations  of  many  different  prices,  we 
find  the  use  of  index  numbers  necessary. 

The  simplest  way  to  form  an  index  number  of  general  changes 
in  prices  is,  first  to  select  a  list  of  things  whose  prices  are  to  be 
taken  into  account,  next  to  ascertain  the  average  price  per 
rrmt  paid  for  each  of  these  things  in  each  successive  month  or 
year  of  the  period  being  studied,  and  finally  to  take  the  sum  of 
these  unit  prices  in  each  of  a  number  of  successive  months  or 
years  as  the  index  numbers.  Such  index  numbers  show  the 
variations  in  the  total  expense  of  a  purchase  consisting  of  one 
unit  each  of  the  commodities  included  in  the  list.  Thus  if 
bananas  of  a  certain  grade  sell  at  a  certain  time  for  15  cents  a 
dozen,  oranges  at  40  cents,  and  peaches  at  25  cents;  and  if  a 
month  later  the  prices  are  20  cents  for  bananas,  50  cents  for 
oranges,  and  20  cents  for  peaches,  the  summed  prices  used  as 
index  numbers  are  80  cents  and  90  cents  respectively.  This 
means  merely  that  the  total  money  cost  of  a  dozen  each  of  these 
fruits  has  increased  by  12^-  per  cent. 

For  some  purposes  we  get  more  significant  results  by  weight- 
ing the  specific  prices  in  accordance  with  the  relative  impor- 
tance of  the  different  commodities.  If,  for  example,  we  think 
that  twice  as  many  bananas  as  peaches  are  ordinarily  used,  and 
three  times  as  many  oranges  as  peaches,  we  may  take  as  our 
weighted  sum  at  the  earlier  date,  .25  plus  (2  X  .15)  plus  (3  x  .40), 
or  Si. 75.  For  the  later  date  the  weighted  sum  is  $2.10,  indi- 
cating a  general  rise  of  20  per  cent  in  the  retail  prices  of  this 
small  group  of  commodities.  Accurate  weighting  is  thus  of 
great  importance  in  forming  index  numbers  from  a  small  list 
of  price  quotations.  If  a  very  large  list  of  prices  is  used,  weight- 
ing becomes  of  less  importance,  for  there  is  no  necessary  con- 
nection between  the  importance  of  a  commodity  and  the 
degree  to  which  it  has  risen  or  fallen  in  price.  Errors  due 
to  the  lack  of  weighting  or  to  imperfect  weighting  thus 
tend  to  offset  each  other.  But  even  with  a  large  and 
thoroughly  representative  list  of  prices,  the  highest  degree  of 
accuracy  in  index  numbers  cannot  be  reached  without  careful 
weighting. 


OTHER  PROBLEMS   IN  MONEY  AND   BANKING       339 

Index  numbers  are,  however,  more  often  constructed  as 
averages  than  as  sums.  Thus  the  ordinary  arithmetic  averages 
of  the  prices  of  these  kinds  of  fruit  at  the  two  dates  are  .80  -s-  3 
and  .90  -f-  3,  or  .27  and  .30  respectively.  The  weighted  arith- 
metic averages  are  1.75  -f-  6  and  2.10  -h  6,  or  .29  and  .35. 
The  averages,  of  course,  indicate  the  same  proportionate  gen- 
eral change  in  prices  as  do  the  sums,  but  when  the  price  list  is 
large  the  use  of  the  average  makes  the  series  of  price  changes 
somewhat  more  easy  to  inspect  and  interpret. 

It  is  a  common  practice  in  making  index  numbers  to  substi- 
tute relative  prices  for  actual  prices  before  summing  or  averag- 
ing them.  The  price  of  each  commodity  at  each  date  is  set 
down  as  a  per  cent  of  its  price  at  some  one  specific  date  (or  of  its 
average  price  during  a  certain  period).  Thus,  in  the  illustra- 
tion already  given,  if  we  use  the  earlier  date  as  the  "  basing 
period,"  the  price  per  dozen  of  each  kind  of  fruit  is  set  down  as 
100.  The  relative  prices  in  the  later  period  then  are :  bananas, 
133;  oranges,  125;  peaches,  80.  This  gives  an  unweighted 
sum  of  338,  and  an  unweighted  arithmetic  average  of  113, 
indicating  an  average  relative  change  in  prices  of  13  per  cent. 
Relative  prices  may  also,  of  course,  be  combined  by  means  of 
weighted  sums  and  averages.  Index  numbers  utilizing  relative 
prices  should  be  constructed  and  interpreted  with  great  cau- 
tion, because  the  results  will  vary  according  as  one  period  or 
another  is  used  as  the  basing  period.  If,  for  example,  in  the 
illustration  already  given,  prices  at  the  later  date  are  used  as  the 
basing  prices,  average  relative  prices  at  the  earlier  date  become 
93,  indicating  an  average  increase  of  only  a  little  over  7  per  cent 
instead  of  the  13  per  cent  indicated  when  the  earlier  prices 
were  used  as  bases.  When  a  large  price  list  is  used  this  particu- 
lar source  of  error  becomes  of  less  (though  not  of  negligible)  im- 
portance. But  there  remains  the  difficulty  that  for  periods 
remote  from  the  basing  period  this  method  exaggerates  a  rise  in 
prices  and  understates  a  fall.1  It  is  accordingly  sometimes  de- 
sirable to  use  chain  index  numbers,  in  which  the  relative  prices 

1  This  grows  out  of  the  fact  that  a  price  cannot  fall  by  more  than  100  per  cent 
but  can  rise  without  definite  limit 


34°  OUTLINES  OF  ECONOMICS 

for  each  successive  period  are  stated  or  expressed  as  per  cents 
of  the  prices  in  the  period  immediately  preceding.  That  is, 
the  base  is  repeatedly  shifted  from  one  period  to  the  next. 

In  constructing  an  index  number  from  relative  prices,  othei 
kinds  of  averages  than  the  ordinary  arithmetic  average  may 
sometimes  be  wisely  used.  The  median  relative  price  is  the 
one  which  divides  all  of  the  relative  prices  for  a  given  date 
into  halves,  —  one  half  being  lower  and  one  half  higher  than 
the  median.  The  median  is  easy  to  find  and  easy  to  interpret. 
Less  used  are  the  mode,  —  the  relative  price  that  occurs  most 
frequently  at  a  given  date,  and  therefore  shows  what  is  in  a 
way  the  most  "  characteristic  "  price  change,  —  and  the  geo- 
metric average,  —  the  wth  root  of  the  relative  prices  of  n  com 
modities.  The  geometric  average  has  a  number  of  advantages. 
It  gives  less  weight  to  extreme  price  variations  than  does  the 
arithmetic  average ;  geometric  averages  of  relative  prices  show 
just  the  same  general  price  changes  as  geometric  averages  of 
actual  prices;  and  the  results  obtained  are  alike  whether  one 
date  or  another  is  chosen  as  the  basing  period.  It  is,  in  prin- 
ciple, the  correct  average  to  use  when  the  problem  is  not  that 
of  finding  the  change  in  the  aggregate  purchasing  power  of 
money,  but  the  (mathematically)  different  problem  of  finding 
the  general  change  in  the  different  ratios  of  exchange  between 
money  and  other  things. 

In  general,  whether  one  kind  of  index  number  is  better  than 
another  usually  depends  upon  the  character  of  the  available 
data  and  the  use  that  is  to  be  made  of  the  results.  For  example, 
if  the  problem  is  that  of  measuring  the  change  in  the  cost  of 
living  of  the  laboring  classes,  the  best  index  number  is  a  sum  or 
average  of  actual  prices,  weighted  in  accordance  with  the  rela- 
tive importance  of  the  different  items  in  the  expenditures  of 
typical  laboring-class  families.  Sometimes  changes  in  prices 
bring  about  such  changes  in  the  relative  amounts  of  different 
things  purchased  that  if,  for  example,  we  are  comparing  the 
cost  of  living  in  two  periods  rather  far  apart,  we  shall  get  differ- 
ent results  according  as  we  weight  our  index  numbers  in  accord- 
ance with  expenditures  in  one  period  or  the  other. 


OTHER  PROBLEMS   IN   MONEY  AND   BANKING       341 

TABLE  III 

Index    Numbers    of  Wholesale    Prices,   Wages,  and  the  Cost  of 
Lwing  in  the  United  States:  1890-1912 


Year 


1892 

1893 
1894 

189S 
1896 
1897 
1898 
1899 
1900 
1901 
1902 

1903 
1904 

1905 
1906 
1907 
1908 
1909 
1910 
1911 
1912 


Wholesale 
Prices  * 


112. 9 

III. 7 

106. 1 

105.6 

96.1 

93-6 

90.4 

89.7 

93-4 

101.7 

110.5 

108.5 

112.9 

1 13.6 

113.0 

"5-9 

122.5 

129-5 
122.8 
126.5 
131.6 
129.2 
133-6 


Wages  - 

Cost  or  Living3 

100.2 

105.6 

100.5 

105.8 

101.8 

103-7 

101.6 

104.6 

96.7 

98.3 

98.2 

96.0 

99 -o 

94.6 

99-3 

94-7 

99.6 

97.1 

103.0 

99-5 

107.0 

105.3 

110.2 

107.5 

1 14.4 

1 1 2.6 

119. 8 

"4-5 

122.6 

115-0 

125-5 

"5-3 

132.0 

120.0 

137. 1 

125.8 

133-5 

125.4 

132.9 

130.0 

137-6 

135-2 

141.0 

133-3 

145.2 

141.0 

1  Bulletin  of  the  United  States  Bureau  of  Labor  Statistics,  No.  173,  p.  126.  An 
unweighted  arithmetic  average  of  the  (relative)  average  yearly  wholesale  prices 
of  about  240  commodities.  Price  quotations  used  are  so  chosen  as  to  constitute 
in  themselves  a  rough  and  unsystematic  weighting.  Average  actual  prices  from 
i8go  to  iSgg  are  used  as  bases. 

2  From  W.  I.  King,  The  Wealth  and  Income  of  the  People  of  the  United  Stales,  p. 
igS-  Weighted  average  of  the  relative  average  wages  per  hour  for  male  wage  earners 
in  various  manufacturing  industries,  railroad  transportation,  mining,  and  agri- 
culture. By  reason  of  paucity  of  data  these  index  numbers  and  those  of  the  cost  of 
living  are  subject  to  wider  margin  of  error  than  those  for  wholesale  prices.  The 
basing  period  includes  the  years  from  i8go  to  i8gg. 

8  From  King,  op.  cit.,  p.  180.  A  weighted  average  of  statistics  for  (1)  retail 
prices  of  food,  (2)  cost  of  fuel  and  light,  (3)  cloth  and  clothing,  (4)  house  furnishing 
goods,  and  (5)  miscellaneous  items.  Relative  prices  are  used  throughout  and  are 
per  cents  of  average  prices  in  the  period  from  1890  to  1899. 


342  OUTLINES   OF   ECONOMICS 

It  is  often  important  to  know  the  distribution  as  well  as  the 
general  trend  of  price  changes.  The  range  of  variation  of  the 
different  relative  prices  might,  for  example,  be  comparatively 
large  above  the  average  and  comparatively  small  below  it. 
These  are  various  ways  of  measuring  and  stating  the  distri- 
bution of  price  changes  but  their  adequate  consideration  would 
lead  us  into  matters  too  technical  for  discussion  here.  The 
whole  matter  of  index  numbers  is  full  of  subtle  difficulties,  some 
of  them  mathematical,  but  more  of  them  demanding  primarily 
a  clear-headed  analysis  of  the  economic  problems  involved. 

Index  numbers  of  prices  and  wages  are  available  for  the 
United  States  for  the  period  since  i860,  and  some  figures  have 
been  compiled  for  earlier  years.  For  the  period  1860-1880 
Mitchell's1  are  the  best;  the  period  from  1890  to  the  present 
is  covered  by  the  United  States  Bureau  of  Labor  Statistics 2  and 
for  the  gap  from  1880  to  1890  Falkner's  are  available.3  Several 
financial  journals  also  publish  tables  of  price  changes.4 

Some  writers  have  suggested  the  possibility  of  a  tabular  mon- 
etary standard,  to  be  maintained  by  frequently  changing  the  money 
unit  in  accordance  with  the  showings  of  an  officially  kept  sys- 
tem of  index  numbers.  To  do  this  by  periodically  altering  the 
amount  of  bullion  in  standard  coin  would  be  impracticable.5 

1  In  his  Gold,  Prices,  and  Wages  under  the.  Greenback  Standard. 

2  In  various  numbers  of  the  Bulletin  of  the  Bureau  of  Labor  Statistics. 

'In  "Aldrich  Report"  on  Wholesale  Prices,  Wages,  and  Transportation,  Senate 
Doc,  32c!  Cong.,  2d  Session,  No.  1304. 

*  For  an  account  of  modern  index  numbers  of  wholesale  prices  see  Bulletin  of  the 
Bureau  of  Labor  Statistics,  No.  173  (July,  1915),  Fart  ii. 

5  Professor  Irving  Fisher  has  suggested  that  the  dollar  might  be  "stabilized" 
by  making  the  real  monetary  standard  a  variable  amount  of  gold  bullion.  Accord- 
ing to  his  plan,  gold  coins  of  the  present  weight  might  be  retained,  but  if  the  official 
index  number  should  show  advancing  prices,  the  mint  price  (in  gold  bullion)  of  gold 
coins  would  be  slightly  increased  and  at  the  same  time  the  gold  coins  in  circulation 
would  be  made  redeemable  at  the  treasury  in  (nearly)  as  much  gold  bullion  as  con- 
stitutes the  increased  mint  price  of  the  coin.  If  prices  show  a  continued  tendency 
to  increase,  the  gold  dollar  would  virtually  become  a  gold  certificate  for  a  consider- 
ably larger  amount  of  gold  bullion  than  it  contains.  This  plan  could  be  so  oper- 
ated, Professor  Fisher  believes,  as  practically  to  eliminate  general  price  changes. 
It  is  dear  that  no  one  nation  could  introduce  such  a  plan,  because  it  would  cause 
highly  objectionable  fluctuations  in  the  price  of  foreign  exchange  and  in  the  domestic 
prices  of  imported  goods  and  of  important  exports.     It  could  be  adopted  for  inter- 


OTHER   PROBLEMS   IN   MONEY  AND    BANKING       343 

while  to  abandon  the  use  of  a  standard  commodity  and  to 
attempt  to  regulate  prices  by  issuing  fiat  money  and  controlling 
the  amount  in  circulation  would  be,  as  we  have  seen,  chimerical. 
A  tabular  standard  of  deferred  payments  might  be  put  in  opera- 
tion by  laws  providing  for  the  increase  or  diminution  of  the 
principal  of  debts  according  to  changes  in  prices.  It  is  prob- 
able, however,  that  this  would  be  satisfactory  to  neither  debtors 
nor  creditors.  Moreover,  should  the  tabular  standard  of 
deferred  payments  be  adjusted  according  to  changes  in  the 
prices  of  commodities,  or  according  to  changes  in  wages  and 
other  incomes,  or  according  to  general  changes  in  the  prices  of 
commodities  and  services  ?  The  really  essential  thing  is  to  have 
a  commodity  standard  of  value  that  shall  be  as  stable  as  pos- 
sible, and  to  maintain  the  convertibility  of  all  other  forms  of 
money  with  it.  With  gold  as  the  standard  of  value,  and  with 
all  other  forms  of  money  redeemable  in  gold,  changes  in  prices 
are  not  apt  to  be  rapid  enough  to  work  much  injustice  to  either 
debtor  or  creditor.  The  compensating  influence  of  changes 
in  the  interest  rate  must  also  be  taken  into  account.  The  ques- 
tion of  the  grievances  of  debtors  and  creditors  has  been  over- 
emphasized as  compared  with  the  really  important  economic 
problems  growing  out  of  general  changes  in  prices.  These  are, 
as  we  have  seen,  first  the  effect  on  business  enterprise,  and 
second,  the  effect  on  the  purchasing  power  of  money  wages 
and  other  forms  of  money  incomes. 


QUESTIONS 

1.  Construct  simple  index  numbers  for  wholesale  prices,  in  one  city, 
covering  a  period  of  a  few  weeks.  (Use  the  market  quotations  in  a  daily 
paper  as  data.) 

2.  How  should  one  construct  index  numbers  that  would  show  the  fluctua- 
tions of  P,  in  the  equation  of  exchange? 

3.  If  half  the  money  in  the  world  were  destroyed,  would  prices  be  doubled  ? 
If  half  the  gold  in  the  world  were  destroyed? 

national  use,  as  Professor  Fisher  shows,  in  the  form  of  a  (variable)  gold-exchange 
standard.     But  there  are  many  practical  difficulties  in  the  way  of  such  a  change. 


344  OUTLINES  OF  ECONOMICS 

4.  Would  an  increase  of  $1,000,000,000  in  bank  notes  have  the  same 
effect  on  prices  in  this  country  as  the  importation  of  $1,000,000,000  in 
gold? 

5.  Explain  the  mechanism  by  which  a  decrease  in  the  quantity  of  money 
affects  prices. 

6.  Report  on  the  changes  of  prices,  of  bank  reserves,  and  of  bank  deposits 
accompanying  the  crises  of  1893  and  1907. 

7.  Report  on  the  socialistic  explanations  of  crises. 

REFERENCES 

(See  also  references  for  Chapters  XIV  and  XV.) 

Davenport,  H.  J.     The  Economics  of  Enterprise,  Chaps,  xvi,  xvii. 

De  Latjnay,  L.     The  World's  Gold. 

Fisher,  Irving.  The  Purchasing  Power  of  Money;  Why  the  Dollar  is 
Shrinking. 

Jones,  E.  D.    Economic  Crises. 

Kemmerer,  E.  W.  Money  and  Credit  Instruments  in  their  Relation  to 
General  Prices. 

Mitchell,  W.  C.  Business  Cycles;  "The  Making  and  Using  of  Index 
Numbers,"  Bulletin  of  the  U.  S.  Bureau  of  Labor  Statistics,  No.  173. 

Moore,  H.  L.    Economic  Cycles. 

Veblen,  Thorstein.     The  Theory  of  Business  Enterprise,  Chap.  v. 

Walsh,  C.  M.  The  Measurement  of  General  Exchange  Value;  The  Funda- 
mental Problem  in  Monetary  Science. 


CHAPTER  XVII 
INTERNATIONAL   TRADE 

The  supply  of  gold,  the  development  of  trade,  money,  bank- 
teg  and  credit,  in  short  all  the  economic  forces  and  institutions 
discussed  in  the  chapters  immediately  preceding,  take  on  special 
complexity  when  they  become  international  in  scope.  The 
fundamental  principles  underlying  international  trade  and  credit 
are  the  same  as  those  underlying  domestic  trade  and  credit  —  a 
truth  too  frequently  forgotten  —  but  trade  between  two  coun- 
tries in  which  language,  banking  institutions,  monetary  units, 
and  monetary  legislation  are  different  presents  special  problems 
which  call  for  separate  treatment. 

Foreign  Exchange.  —  In  the  beginning  a  brief  description 
must  be  given  of  the  mechanism  of  foreign  exchange.  In  in- 
ternational as  in  domestic  trade,  only  a  small  amount  of  money 
is  used,  compared  to  the  enormous  money  values  of  the  goods 
exchanged.  Purchase  is  set  against  sale,  debt  canceled  by 
credit,  and  money  is  employed  only  for  the  occasional  settlement 
of  balances.  This  cancellation  of  offsetting  claims  is  effected 
by  the  banks  and  bankers  who  engage  in  foreign  exchange. 
Their  work  is  indispensable  in  the  development  of  foreign  trade. 
The  European  War,  for  instance,  by  interrupting  traffic  between 
Europe  and  South  America  opened  up  large  export  possibilities 
to  American  manufacturers ;  but  it  was  found  impossible  to 
take  large  or  immediate  advantage  of  this  opportunity,  partly 
because  the  necessary  banking  and  credit  connections  had  not 
been  established  between  South  America  and  this  country. 

As  illustrative  of  the  processes  of  foreign  exchange,  let  us  take 
our  trade  with  England.  Ordinarily,  an  American  exporter 
who  has  sold  goods  to  England  draws  an  order  —  a  bill  of  ex- 
change —  on  the  English  debtor,  directing  him  to  pay  the  claim 

345 


346  OUTLINES  OF  ECONOMICS 

at  some  specified  time  and  place  in  London.  American  im- 
porters, on  the  other  hand,  commonly  pay  their  foreign  balances 
by  buying  bills  of  exchange  or  drafts  on  London,  and  sending 
them  to  their  English  creditors.  In  this  way  American  debts 
and  credits  are  balanced  in  London  without  transferring  any 
money  at  all,  except  occasionally  to  settle  the  balance  of  in- 
debtedness. 

Bills  of  exchange  drawn  on  a  commercial  debtor  are  usually 
accompanied  by  bills  of  lading,  insurance  receipts,  certificates 
of  weight  and  origin,  and  all  the  documents  necessary  to  give 
the  purchaser  of  the  bill  full  title  to  the  goods  until  the  bill  is 
accepted  or  paid.  They  are  accordingly  referred  to  as  "  docu- 
mentary bills  "  or  "  commercial  bills,"  to  distinguish  them  from 
"  bankers'  bills  "  and  other  instruments  of  international  credit 
described  hereafter.  Documentary  bills  are  freely  negotiable, 
passing  from  hand  to  hand  by  indorsement,  and  gathering 
strength  with  each  new  indorsement.  It  is  important,  also, 
to  note  the  difference  between  "  sight  bills  "  and  "  long  bills," 
the  former  calling  for  payment  upon  presentation,  the  latter 
usually  for  immediate  "  acceptance  "  by  the  drawee  x  and  pay- 
ment after  thirty,  sixty,  or  ninety  days.  The  price  of  long  bills 
is  fixed  by  the  price  of  sight  bills  and  the  discount  rate  in 
London. 

We  may  now  enlarge  our  simplified  illustration  to  something 
like  life  size.  Documentary  bills  drawn  by  exporters  or  creditors 
all  over  the  country  are  sold  by  the  drawers  to  bankers,  usually 
New  York  bankers,  who  may  be  called  the  "  wholesalers  of 
exchange.'  The  sale  may  be  either  direct  or  through  exchange 
brokers,  "  the  jobbers  of  exchange."  These  documentary  bills 
are  sent  by  the  New  York  banks  to  their  foreign  correspondents 

1  "Acceptance"  of  a  bill  definitely  obligates  the  acceptor  to  pay  it.  Many  im- 
porters arrange  to  have  bills  drawn  upon  them  accepted  by  some  bank,  protecting 
the  accepting  bank  by  a  deposit  of  collateral  and  paying  it  a  commission  for 
its  service?.  Bills  accepted  by  banks  ("bankers'  acceptances")  command  a  very 
low  rate  of  discount,  and  are  for  many  reasons  very  desirable  elements  in  an  "open 
discount  market."  The  federal  reserve  banks  are  seeking  to  develop  the  use  of 
(jankers'  acceptances  in  the  United  States.  National  banks  are  now  empowered 
to  accept  bills  of  exchange  originating  in  foreign  trade. 


INTER  NATIONAL  TRADE  347 

for  collection  (in  the  case  of  sight  bills)  or  acceptance  (in  the 
case  of  long  bills).  The  balances  thus  built  up  abroad  by  the 
New  York  banks  constitute  the  fund  against  which  they  draw 
their  own  bills.  These  are  sold  directly  or  through  smaller 
banks  —  the  "  retailers  of  exchange  "  —  located  in  all  parts  of 
the  country.  Foreign  exchange  is  sold  in  a  great  variety  of 
forms  —  bankers'  drafts,  travelers'  checks,  travelers'  letters  of 
credit,  commercial  letters  of  credit,  cable  transfers,  and  the 
like  —  descriptions  of  which. may  be  found  in  the  references 
given  at  the  end  of  the  chapter. 

The  illustrations  used  above,  while  typical  of  a  large  part  of 
the  foreign  exchange  of  this  country,  fail  to  represent  adequately 
the  complexity  which  marks  some  of  the  interactions  of  inter- 
national credit.  An  illustration  of  the  more  complex  class  is 
found  in  the  "  three-cornered "  or  "  triangular  exchange." 
We  import  from,  very  much  more  than  we  export  to,  South 
America.  A  part  of  the  debit  balance  —  though  possibly  not 
the  larger  part  at  the  present  time  —  is  settled  by  the  transmis- 
sion of  London  drafts  to  our  South  American  creditors,  who  can 
use  them  advantageously  in  the  settlement  of  their  debts  in 
Europe.  Our  rate  of  exchange  with  any  particular  foreign 
country  is  therefore  controlled  not  by  our  trade  with  that 
country,  but  by  our  dealings  or  general  balance  with  the  rest 
of  the  world ;  and  London  "  clears  "  for  the  world  as  New 
York  "  clears  "  for  America  and  Paris  for  France.  Just  as 
the  net  balance  of  our  domestic  trade  is  struck  in  New  York, 
so  final  international  balances  are  cleared  or  settled  in  London, 
although  London's  preeminence  in  international  exchange  is  not 
now  so  striking  as  it  has  been  in  the  past.  The  European  war 
transferred,  for  the  time  being  at  least,  a  considerable  amount 
of  this  business  to  New  York. 

The  question  next  arises  how  the  price  or  rate  of  exchange  is 
determined.  The  factors  controlling  the  price  or  rate  of  ex- 
change are  as  numerous  and  as  difficult  to  trace  as  the  influences 
which  affect  the  price  of  any  economic  good  of  world-wide 
purchase  and  sale.  However,  to  facilitate  discussion,  we  may 
classify  them  as :  (1)  the  amount  of  pure  gold  in  the  monetary 


348  OUTLINES  OF  ECONOMICS 

units  which  are  to  be  exchanged,  (2)  the  cost  of  shipping  gold, 
and  (3)  "  general  credit  conditions." 

An  English  pound  sterling  contains  as  much  fine  gold  as  4.866 
American  dollars,  and  when  exactly  this  amount  must  be  paid  in 
New  York  for  a  draft  or  order  for  one  pound  payable  in  London, 
exchange  is  said  to  be  at  par.  Sterling  exchange  and  German 
exchange  are  usually  quoted  in  dollars  and  cents,  i.e.  the  amount 
of  American  money  required  to  buy  one  pound  or  four  marks 
respectively.  Consequently,  they  rise  or  become  dear  when 
exchange  mounts  above  par.  French  exchange,  on  the  contrary, 
is  usually  quoted  in  francs,  the  number  of  francs  purchasable 
with  one  dollar ;  and  it  is  consequently  cheap  when  above  par 
and  dear  when  below  par.  Exchange  between  the  United  States 
and  countries  with  silver  or  paper  standards  lacks  the  steadying 
influence  of  a  par  determined  by  the  actual  mass  of  fine  gold  in 
the  respective  units  of  value,  and  hence  fluctuates  much  more 
than  exchange  between  countries  on  a  gold  basis.  In  order  to 
be  as  brief  and  clear  as  possible,  the  following  discussion  will 
be  confined  to  exchange  between  countries  on  a  gold  basis. 

Fluctuations  in  the  rate  of  exchange  depend  chiefly  upon  the 
"  general  credit  conditions  "  mentioned  above,  but  it  is  plain 
that  upper  and  lower  limits  to  these  variations  are  established 
by  the  actual  cost  of  shipping  gold.  Suppose,  for  a  moment, 
that  it  costs  two  cents  to  transport  $4,866  worth  of  gold  bullion 
between  New  York  and  London.  Except  under  unusual  cir- 
cumstances, then,  sterling  exchange  could  not  rise  above  $4,886, 
nor  fall  below  $4,846.  Such  limits  are  frequently  spoken  of 
as  the  "  gold  points,"  "  specie  points,"  "  shipping  points,"  or 
"  export  and  import  points  " ;  and  it  is  necessary  to  mention 
them  because  of  their  frequent  employment  in  discussions  of 
foreign  exchange.  But  they  are  usually  defined  in  much  too 
definite  terms.  The  cost  of  shipping  gold  varies  with  the  size 
of  the  shipment,  with  freight,  insurance,  and  interest  rates, 
and  in  some  degree  with  the  steamer  and  the  season  of  the  year. 
Furthermore,  gold  is  so  important  as  the  basis  of  bank  credit  in 
all  parts  of  the  world  that  it  is  frequently  imported  regardless 
of  the  rate  of  exchange.    During  the  war  between  Russia  and 


INTERNATIONAL   TRADE  349 

Japan,  for  instance,  the  Bank  of  France  imported  large  quanti- 
ties of  American  gold  in  this  semiarbitrary  way  in  order  to  pro- 
tect reserves.  The  "  gold  points,"  then,  while  in  one  sense  very 
real,  represent  extreme  limits  and  are  in  themselves  variable. 

Within  these  extreme  limits  set  by  the  cost  of  shipping  gold, 
the  rate  of  exchange  varies  according  to  general  credit  condi- 
tions, i.e.  with  the  supply  of  and  demand  for  bills  of  exchange, 
with  discount  rates  here  and  abroad,  and  the  innumerable  forces 
which  influence  discount  rates.  Suppose,  for  instance,  that  our 
imports  of  merchandise  in  a  given  season  greatly  exceed  our  ex- 
ports of  merchandise.  The  demand  for  bills  on  London  would 
greatly  exceed  the  supply  of  bills  on  London,  and  the  price 
of  sterling  exchange  would  rise  very  high  if  no  other  factors  were 
involved.  But  it  may  happen  at  the  same  time  that  interest 
rates  in  New  York  are  higher  than  in  London,  and  under  these 
circumstances  our  foreign  creditors  may  prefer  to  lend  their 
balances  in  New  York  in  order  to  earn  the  high  rate  of  interest 
obtaining  there.  The  placing  of  these  loans  in  New  York  will 
in  turn  reduce  the  demand  for  foreign  exchange,  and  thus  moder- 
ate both  the  interest  rate  and  the  rate  of  exchange. 

After  the  beginning  of  the  European  War,  conditions  became 
exactly  the  reverse  of  those  assumed  in  the  preceding  illustra- 
tion. Europe  bought  enormous  quantities  of  goods  in  this 
country,  there  was  an  unprecedented  excess  of  exports  over 
imports  and  a  corresponding  drop  in  the  rate  of  exchange.  We 
loaned  large  sums  to  Europe,  extending  credits  to  foreign  pur- 
chasers and  buying  government  securities.  We  also  bought 
back  a  very  considerable  quantity  of  American  securities.  All 
this  is  indicative  of  the  dependence  of  international  trade  upon 
international  credit  and  banking,  of  the  fact  that  if  we  sell  to 
foreigners  we  must  buy  from  them  or  give  them  credit,  of  the 
interdependence  of  foreign  exchange,  interest  rates,  and  the 
territorial  distribution  or  placing  of  credit.  But  it  is  more  in- 
dicative, perhaps,  of  the  facts  that  the  stock  of  gold  is  a  world 
stock,  that  the  credits  resting  upon  it  tend  to  flow  to  the  point 
where  they  command  the  highest  price,  that  the  foreign  ex- 
changes evince  normally  a  strong  aversion  to  the  actual  move- 


350  OUTLINES  OF   ECONOMICS 

ment  of  gold,  and  that  trade  balances  are  for  the  most  part 
settled  by  the  shifting  of  credits  and  securities. 

This  interaction  of  the  domestic  and  the  international  money 
markets  gives  rise  to  a  number  of  complex  transactions  which 
can  only  be  suggested  here.  In  discussing,  on  page  347,  the 
sale  of  foreign  exchange,  American  bankers  were  described 
as  drawing  against  credit  balances  which  they  had  built  up 
abroad.  Some  bankers'  bills,  however,  the  so-called  "  finance 
bills,"  are  drawn  in  excess  of  the  foreign  balances,  and  thus  repre- 
sent borrowings  abroad.  Finance  bills  are  used  (1)  to  tide 
over  the  time  before  a  plentiful  supply  of  documentary  bills  is 
available;  and  (2)  to  take  advantage  of  low  discount  rates 
abroad,  e.g.  in  London,  by  borrowing  in  London  and  lending  the 
proceeds  in  New  York.  Under  the  latter  circumstances,  finance 
bills  payable  in  London  at  sixty  or  ninety  days  are  sold  in  large 
quantities  in  New  York,  the  sellers  commonly  covering  their 
risk  by  the  purchase  of  future  drafts  calling  for  the  payment 
of  the  same  amounts  in  London  at  the  dates  when  the  bills 
mature.  The  finance  bill  is  thus  one  of  many  credit  instruments 
used  to  bring  the  loanable  funds  of  the  world  to  the  market  where 
they  will  command  the  highest  rate  of  interest ;  and  it  is  hardly 
necessary  to  add  that  it  assumes  at  times  a  highly  speculative 
character.  "  Bankers  sometimes  purchase  outright  entire  new 
issues  of  securities  from  corporations  with  proceeds  obtained  by 
the  issue  of  finance  bills,  sell  the  securities  to  investors  during 
the  currency  of  the  finance  bills,  and  apply  the  proceeds  realized 
through  the  sale  of  the  securities  to  the  payment  of  the  bills  at 
maturity."  1 

Regulation  of  the  Gold  Supply.  —  As  explained  above,  com- 
paratively little  gold  is  used  directly  in  international  trade. 
Yet  there  is  nearly  always  some  movement  of  gold.  In  the 
regular  course  of  her  foreign  trade,  London  is  constantly  shipping 
and  receiving  gold,  and  the  same  is  true  in  a  general  way  of  this 
country.  In  January,  1914,  for  instance,  $10,442,373  in  gold 
was  imported,  while  the  exports  of  gold  in  the  same  month 
amounted  to  $6,914,056. 

1  A.  W.  Margraff,  International  Exchange,  p.  41. 


INTERNATIONAL   TRADE  351 

In  normal  times,  the  discount  rate  is  frequently  used  to  regu- 
late the  distribution  of  gold,  part\  ularly  in  countries  having 
central  banks.  International  banking  houses  keep  funds  in 
both  the  United  States  and  Europe,  and  they  are  constantly 
shifting  their  money  to  the  market  in  which  it  will  earn  the  high- 
est rate  of  interest.  The  means  employed  to  move  their  funds 
may  vary,  as  has  been  explained,  all  the  way  from  the  simple 
sale  of  foreign  exchange  to  the  actual  importation  of  gold.  So 
great  is  the  influence  exercised  by  the  discount  rate  over  the 
gold  supply  that  the  Bank  of  England,  as  we  have  seen,  usually 
finds  it  necessary  to  do  nothing  more  than  raise  its  discount 
rate  when  it  desires  to  attract  gold  to  England  or  discourage  its 
exportation.  But  it  is  important  here  not  to  confuse  the  causal 
relationship.  The  discount  rate  does  not  control  the  flow  of 
gold  any  more  truly  than  the  flow  of  gold  controls  the  discount 
rate.  The  two  are  mutually  dependent,  and  both  in  turn  are 
subject  to  other  independent  influences. 

The  ordinary  price  level,  that  is,  of  merchandise,  similarly 
affects  the  rate  of  exchange  and  the  movement  of  gold.  When 
prices  abroad  are  high  compared  with  American  prices,  foreign 
countries  increase  their  purchases,  the  supply  of  American 
bills  increases,  sterling  exchange  falls,  and  if  it  goes  low  enough, 
may  cause  the  shipment  of  gold  to  this  country.  Such  a  condi- 
tion of  affairs,  for  instance,  is  likely  to  occur  in  the  autumn 
months,  when  large  exportations  of  American  cotton,  wheat, 
and  agricultural  products  create  a  plethora  of  bills  on  London, 
and  other  things  being  equal,  depress  the  price  of  sterling  ex- 
change. 

There  can  be  no  doubt,  then,  that  the  price  level  does  influence 
the  movement  of  gold.  It  seems  equally  clear  that  the  gold 
movement  influences  prices.  Some  opponents  of  the  "  quantity 
theory  "  of  prices  hold  that  it  does  not,  maintaining  that  before 
a  drain  of  gold,  for  instance,  could  raise  prices,  it  would  so  ele- 
vate the  discount  rate  that  the  drain  would  be  checked.  In  their 
view,  the  discount  rate  acts  as  a  safety  valve,  through  whose 
variations  any  protracted  gold  movement  which  threatens  to 
disturb  the  price  level  is  checked  and  reversed  before  it  acquires 


352  OUTLINES  OF  ECONOMICS 

the  momentum  requisite  to  accomplish  the  larger  task.  But 
this  assertion  is  for  present  purposes  irrelevant.  It  makes  little 
difference  whether  the  supply  of  gold  acts  through  the  discount 
rate  or  directly.  It  acts.  And  we  may  be  sure  at  least  that  if 
the  movement  of  gold  continued  indefinitely,  prices  would  un- 
questionably be  affected.  Nor  should  it  be  forgotten  that  a 
low  discount  rate  itself  affects  the  price  level.  In  any  event  no 
country  need  fear  the  exhaustion  of  its  specie.  A  protracted 
excess  of  imports  over  exports  commonly  arouses  apprehen- 
sions on  the  point.  Such  fears  are  groundless.  A  continued 
outflow  of  gold  raises  discount  rates,  tends  to  reduce  prices, 
and  so  draws  back  the  specie  through  either  new  loans  or 
new  purchases  or  both. 

The  gold  supply  thus  adjusts  itself  automatically  to  the  respec- 
tive demands  of  the  various  districts  of  the  world.  This  truth 
is  important  because  it  establishes  a  prima  facie  presumption 
against  laws  or  policies  which  interfere  with  the  normal  distri- 
bution of  the  precious  metals.  This  presumption  is  only  an 
initial  one,  however.  It  does  not  follow  that  "  artificial  "  inter- 
ference with  the  distribution  of  the  gold  supply  is  never  war- 
ranted. Gold  is  purchasing  power,  representing  universal  and 
instantaneous  command  over  men  and  things,  and  as  the  foun- 
dation of  bank  credit  it  is  not  too  much  to  say  that  upon  it 
modern  industrial  civilization  rests.  The  governments  of  to-day 
are  dependent  in  many  ways  upon  the  banks,  and  for  this 
reason  the  movement  of  gold  must  continue  to  be  as  responsive 
to  national  political  demands  as  to  interest  rates  and  prices. 
Gold  may  be  obtained  not  only  in  the  course  of  international 
trade,  as  that  term  is  ordinarily  understood,  but  by  liquidating 
international  debts.  From  the  period  just  preceding  the  Balkan 
War  until  the  outbreak  of  the  European  conflict,  Europe  steadily 
liquidated  or  sold  back  its  American  securities,  inspired  either 
by  a  general  feeling  of  political  insecurity  or  by  definite  prevision 
of  approaching  hostilities.  Gold  moved  in  this  case  in  obedience 
to  forces  at  once  political  and  commercial ;  the  regulation  was 
both  "natural"  and  "artificial." 

In  times  of  war,  panic,  or  severe  financial  stringency,  extraor 


INTERNATIONAL  TRADE  353 

dinary  expedients  for  obtaining  gold  are  sometimes  used  which, 
like  the  heroic  remedies  employed  in  desperate  illness,  are  necessi- 
tated by  the  exigencies  of  the  situation.  In  the  scramble  for 
gold  which  precedes  a  war  or  attends  a  panic,  the  country  or  the 
individual  who  stands  aloof  and  waits  for  the  normal  laws  of 
distribution  to  bring  him  "  his  "  share  of  the  gold  supply  may 
have  cause  to  regret  his  inaction.  Nevertheless,  it  is  true  that 
such  expedients,  like  strong  drugs,  are  to  be  used  with  great 
caution.  They  are  frequently  employed  when  the  situation 
does  not  demand  them,  their  use  tends  to  become  a  fixed  habit, 
and  they  seldom  accomplish  more  than  the  postponement  of  the 
crisis.  An  expedient  of  the  kind  described  was  employed  by 
Mr.  Shaw,  then  Secretary  of  the  Treasury,  in  the  spring  of  1906. 
The  following  critical  account  of  the  action  of  the  Secretary  may 
be  unjust  to  him,  for  it  must  be  remembered  that  the  financial 
stringency  of  the  time  threatened  to  become  dangerous ;  but  it 
illustrates  in  a  striking  way  the  subtle  modern  devices  sometimes 
used  to  increase  the  supply  of  gold. 

'On  April  14  it  was  officially  announced  for  the  first  time,  that  the  Sec- 
retary would  allow  any  depositary  bank  which  engaged  to  import  gold  to 
anticipate  the  arrival  of  the  gold  by  withdrawing  a  like  amount  in  cash  from 
the  Treasury  upon  pledge  of  savings-bank  collateral  as  security.  The  sum  so 
withdrawn  was  to  be  regarded  as  a  temporary  loan,  and  to  be  returned  to  the 
Treasury  as  soon  as  the  gold  arrived.  In  providing  such  an  arrangement,  Mr. 
Shaw  virtually  reduced  the  cost  of  importing  gold  by  the  amount  of  interest 
during  transit,  and  raised  by  so  much  the  'gold  import  point.'  In  other 
words,  he  endeavored  to  make  it  profitable  for  the  depositary  bank  to 
import  gold  without  waiting  for  sterling  exchange  to  fall  to  the  normal 
'gold  point.'  ...  In  accomplishing  this,  Mr.  Shaw  temporarily  elimi- 
nated, so  far  as  the  national  banks  were  concerned,  one  item  of  expense  in 
their  foreign  exchange  operations.  He  gave  them  an  advantage,  for  the 
time  being,  over  all  other  Lims  engaged  in  the  same  business;  and  his 
action  naturally  excited  criticism  among  the  private  bankers  who  found 
themselves  discriminated  against.  Critics  also  attacked  his  method  of 
announcing  his  decision.  It  appeared  that  several  days  before  the  public 
or  the  other  banks  were  informed  of  his  intention,  Mr.  Shaw  had  seen  fit 
to  make  private  arrangements  with  two  New  York  banks  for  gold  imports 
under  the  plan  .  .  .  Nor  was  hostile  criticism  mitigated  by  the  general 
publication  at  this  moment  of  the  fact,  which  had  not  been  widely  known 
before,  that  one  of  these  same  banks  had  been  favored  by  the  Treasury  for 


354  OUTLINES  OF   ECONOMICS 

several  weeks,  and  possibly  months,  preceding,  with  virtually  the  same 
privilege  under  a  different  guise.  This  had  been  accomplished  by  allowing 
the  bank  in  question  to  count  as  part  of  its  reserve  its  importations  of  gold 
during  their  period  of  transit  to  New  York.  The  imported  gold  had  thus 
been  made  practically  available  as  a  basis  for  loans  from  the  moment  of  its 
purchase  abroad,  and  the  item  of  time  cost  in  such  imports  had  been  as 
completely  eliminated  as  under  the  subsequently  adopted  plan.  .  .  .  His 
[Secretary  Shaw's]  statement  issued  at  the  time  seemed  to  indicate  that, 
in  his  opinion,  the  natural  movement  of  gold  was  toward  this  country,  but 
that  the  flow  was  being  lured  to  other  markets  by  the  practices  of  European 
banks.  He  apparently  hoped  to  overcome  what  he  took  to  be  an  artificial 
diversion  of  gold  from  the  United  States  by  adopting,  through  the  agency 
of  the  Treasury,  measures  similar  to  those  which  were  being  employed  by 
the  French  and  German  central  banks."  1 

It  is  this  fear  of  panic  and  fear  of  war  that  to  a  large  degree 
explain  the  actual  shipment  of  gold,  with  its  risk,  expense,  and 
loss  by  abrasion.  If  we  could  be  assured  of  permanent  peace 
and  had  a  perfect  credit  system  most  of  the  gold  movement 
would  be  unnecessary.  If  London  were  entitled  to  a  gold 
balance  from  New  York,  a  negotiable  instrument  evidencng 
that  debt  would  under  most  circumstances  suffice ;  or  the  gold 
could  actually  be  set  aside  in  the  vaults  of  the  New  York  sub- 
treasury,  marked  with  a  London  label  and  held  until  an  opposite 
state  of  exchanges  made  it  necessary  to  change  the  labels. 

The  Balance  of  Trade. — Although  credit  devices  make  it 
unnecessary  to  settle  current  trade  balances  with  gold,  the  notion 
still  persists  that  an  excess  of  merchandise  exports  is  a  good 
thing  and  an  excess  of  merchandise  imports  a  bad  thing.  We 
still  speak  of  the  former  as  a  "  favorable  "  and  of  the  latter  as  an 
"  adverse  "  balance.  To  sell  abroad  as  much,  and  to  buy 
abroad  as  little  as  possible  still  seems  the  ideal  of  many  well- 
meaning  legislators  and  intelligent  journalists. 

Suppose  for  the  purposes  of  discussion  that  the  United  States 
succeeded  in  prohibiting  imports  for  a  long  period,  while  at  the 
same  time  it  succeeded  in  selling  a  large  amount  of  merchandise 
to  foreign  purchasers.  What  would  happen?  Evidently  a 
large  portion  of  the  money  of  the  world  would  accumulate  in 

1  A.  P.  Andrew,  Quarterly  Journal  of  Economics,  Vol.  xxi,  pp.  544-546. 


INTERNATIONAL  TRADE  355 

the  vaults  of  American  bankers,  interest  rates  would  fall,  — 
possibly  to  rise  again  later,  —  and  eventually,  if  the  process 
continued  long  enough,  the  prices  of  American  commodities 
would  ascend  to  such  a  level  that  foreign  nations  would  be  un- 
able to  continue  buying  in  this  country.  At  this  point,  evidently, 
our  hypothesis  breaks  down,  and  we  are  forced  to  conclude  that 
the  original  supposition  was  an  impossible  one. 

This  hypothetical  case  and  its  reductio  ad  absurdum  are  suffi- 
cient to  establish  certain  important  pratical  conclusions.  The 
first  is  that  a  country  cannot  permanently  sell  goods  for  money 
alone.  If  it  produces  large  quantities  of  the  money  metals,  it 
will  regularly  sell  those  metals  for  the  goods  and  services  of  other 
nations.  If  it  produces  no  gold  or  silver  itself,  it  will  secure  them 
through  exchange;  although,  even  in  this  case,  gold  and  silver 
are  likely  to  constitute  only  a  minor  part  of  its  imports.  Perhaps 
the  gravest  error  one  can  commit  in  studying  an  international 
trade  balance  is  to  treat  it  as  an  exchange  of  goods  for  money. 
It  is  not  even  an  exchange  of  goods  for  goods.  The  true  inter- 
national balance  is  one  of  claims  against  obligations,  of  credits 
against  debits.  The  complete  statement  is  that  the  goods, 
moneys,  and  services  rendered  by  one  country  to  other  countries, 
plus  its  claims  and  credits  of  all  kinds,  will  be  balanced  by  the 
goods,  moneys,  and  services  received  by  the  same  country  plus 
its  debts  and  obligations  of  all  kinds.  Or,  to  put  the  matter 
concretely,  we  must  include,  along  with  the  exports  and  imports 
of  merchandise  and  bullion,  the  invisible  exchanges,  loans  which 
the  country  makes  or  receives,  annual  interest  payments  on 
loans  and  capital  invested  abroad,  repayment  of  loans  or  the 
purchase  of  securities,  earnings  of  ships,  insurance  premiums, 
and  commissions  of  all  kinds  for  international  services,  govern- 
mental expenditures  in  foreign  countries  for  diplomatic  service, 
payment  of  subsidies  and  war  indemnities,  remittances  of  im- 
migrants, expenditures  of  travelers,  and  a  thousand  and  one 
other  items,  all  tending,  according  as  they  depress  or  raise  the 
price  of  foreign  exchange,  to  bring  about  the  importation  or  ex- 
portation of  gold  for  the  occasional  balancing  of  the  account. 

A  mere  glance  at  this  list  of  items  entering  into  foreign  trade  is 


356  OUTLINES  OF  ECONOMICS 

sufficient  to  puncture  the  old  mercantilist  idea  that  a  "  favor- 
able balance  of  trade  "  or  an  excess  of  merchandise  exports 
brings  about  an  increase  of  the  money  supply.  This  idea  is  as 
fully  refuted  by  commercial  statistics  as  by  economic  analysis. 
In  the  thirty-three  years,  1874-1906,  for  instance,  we  had  a  large 
excess  of  merchandise  exports  in  all  except  four  years,  but  there 
was  an  excess  of  gold  imports  in  only  sixteen  years.  So,  similarly, 
there  was  probably  little  truth  in  the  statement  heard  so  fre- 
quently when  the  previous  edition  of  this  work  was  published 
(1908),  that  our  then  "  favorable  balance  "  indicated  that  the 
United  States  was  settling  its  indebtedness  to  foreign  capitalists, 
repurchasing  American  securities  owned  abroad,  and  thus  bring- 
ing the  control  of  American  enterprises  more  completely  into 
the  hands  of  Americans.  It  may  have  meant  this,  to  be  sure, 
but  it  more  probably  meant  that  we  were  paying  England  in 
goods  for  carrying  and  insuring  our  exports,  or  that  foreign 
owners  of  American  securities  were  taking  in  this  form  the  annual 
interest  or  profits  due  to  them.  That  excess  of  exports  repre- 
sented the  continuance  of  indebtedness  rather  than  its  liquida- 
tion. 

For  the  same  reasons  an  "  unfavorable  balance  of  trade  "  or 
an  excess  of  merchandise  imports  is  open  to  a  variety  of  different 
interpretations.  It  may  mean  that  foreign  capital  is  investing 
more  heavily  in  the  country  under  discussion,  or  that  the  latter 
country  is  taking,  in  the  form  of  consumable  commodities, 
interest  and  profits  on  investments  which  it  has  previously  made 
abroad,  or  that  it  is  selling  its  holdings  in  foreign  enterprises 
and  taking  the  proceeds  in  the  form  of  consumable  goods.  An 
"  unfavorable  balance  "  of  trade  may  thus  be,  in  reality,  highly 
encouraging;  and  a  "  favorable  balance  "  indicative  of  national 
waste  and  extravagance.  The  precise  meaning  of  any  partic- 
ular balance  can  be  determined  only  after  the  most  careful 
study,  and  no  dependence  should  be  placed  upon  the  offhand 
interpretations  of  casual  investigators.  The  great  truth  is  that 
there  must  be  some  sort  of  balance  between  the  credits  and 
liabilities  of  any  country,  and  that  in  practice  a  nation  must  be 
willing  to  buy  if  it  is  anxious  to  sell. 


INTERNATIONAL  TRADE  357 

A  scholarly  analysis  of  the  foreign  trade  of  the  United  States,  with  a  careful 
interpretation  of  the  meaning  of  the  trade  balance  at  various  periods,  may 
be  found  in  the  North  American  Review  for  July,  1901,  from  the  pen  of 
Professor  C.  J.  Bullock.  Professor  Bullock's  explanation  of  the  balance  in 
two  or  three  periods  may  be  given,  in  order  to  illustrate  the  variety  of  factors 
which  must  be  taken  into  account  when  dealing  with  this  subject.  In  the 
period  1 789-1820  the  imports  of  merchandise  and  specie  exceeded  the  cor- 
responding exports  by  $511,000,000,  and  our  obligations  were  further  in- 
creased by  interest  on  foreign  capital  invested  in  the  United  States  to  the 
amount  of  $200,000,000  approximately.  This  total  indebtedness  of  some- 
thing over  $700,000,000  was  offset  by  the  earnings  of  the  American  mer- 
chant marine,  estimated  at  about  $800,000,000  for  the  period  in  question. 
"So  far,  then,  from  the  country  being  drained  of  its  money  in  payment  for 
the  balance  of  imported  merchandise,  the  banks  held  not  less  than  $20,000,- 
000  of  specie  in  the  year  1820;  while  Gallatin  and  Crawford  estimated  that 
there  had  never  been  more  hard  cash  in  circulation." 

In  the  decade  1831-1840,  owing  to  the  high  prices  current  in  this  country, 
imports  exceeded  exports  by  $159,700,000;  the  imports  of  specie  also  ex- 
ceeded the  exports  by  $50,650,000 ;  and  the  earnings  of  our  merchant  marine, 
$90,000,000,  sufficed  only  to  reduce  this  "unfavorable  balance"  to  about 
$120,000,000.  This  remaining  balance  is  accounted  for  by  new  foreign 
investments  in  the  United  States,  in  particular  by  foreign  purchases  of  state 
bonds.  "Our  large  imports  of  merchandise  and  specie  had  been  made 
necessary  by  the  movement  of  foreign  capital  toward  the  United  States." 

In  the  decade  1851-1860  the  merchandise  imports  again  exceeded  the 
exports  by  $355,800,000 ;  the  net  amount  due  to  foreign  creditors  was  some- 
where between  $100,000,000  and  $130,000,000;  and  to  offset  these  adverse 
balances  our  merchant  marine  earned  in  this  period  only  $158,000,000.  The 
remaining  balance  in  this  case  was  covered  by  our  large  excess  of  specie 
exports,  which  amounted  to  $417,608,000,  and  was  due  to  the  discovery  of 
gold  in  California.  "The  United  States  had  become  one  of  the  leading  gold- 
producing  regions,  and  the  course  of  the  exchanges  was  inevitably  altered." 

In  the  periods  briefly  described  above,  the  striking  factors  in  our  inter- 
national trade  were,  respectively,  the  earnings  of  our  merchant  marine,  new 
investments  of  foreign  capital  in  the  United  States,  and  large  specie  exports 
following  the  discovery  of  gold  in  California.  In  the  last  period,  from  1874 
to  1896,  our  exports  both  of  merchandise  and  specie  greatly  exceeded  our 
imports.  "This  meant  simply,"  concludes  Professor  Bullock,  "that  the 
country  had  assumed  its  normal  position  as  a  debtor  nation  on  the  various 
items  of  invisible  exchanges,  and  was  paying  annually  something  like  $122,- 
500,000  on  such  accounts." 

The  movement  just  preceding  the  European  War  was  marked  by  features 
of  unusual  interest.  From  1910  to  1914  this  country  had  a  normal  excess 
of  exports.    In  April,  1914,  however,  an  "adverse"  balance  showed  itself, 


358  OUTLINES   OF   ECONOMICS 

and  in  the  same  month  gold  began  to  flow  to  Europe ;  the  $50,000,000 
mark  was  reached  in  the  middle  of  June  and  by  the  end  of  November  the 
excess  of  gold  exports  amounted  to  $175,000,000.  In  the  beginning  the 
outflow  of  gold  was  attributed  to  the  Underwood  tariff,  which  stimulated 
imports  by  reducing  duties.  But  gold  continued  to  flow  for  a  considerable 
time  after  the  excess  of  merchandise  imports  had  given  way  to  an  unprec- 
edented excess  of  exports.  As  a  matter  of  fact  the  continued  exodus  of 
gold  was  due  far  more  to  a  wild  scramble  for  gold  abroad,  particularly  on 
the  part  of  Russia;  to  the  forced  "importation"  of  American  securities 
from  Europe;  and  to  large  European  loans  placed  in  this  country  than  to 
the  excess  of  merchandise  imports  in  the  spring  of  1914.  The  movement 
of  American  securities,  it  may  be  noted,  began  long  before  the  declaration 
of  war  and  may  possibly  have  marked  the  initial  preparations  for  that 
conflict. 

Despite  the  continuance  of  heavy  European  borrowings,  our  decreased 
importations  from  Europe  and  our  heavy  exports,  especially  of  munitions, 
turned  the  tide  in  December.  The  excess  of  gold  imports  over  gold  exports 
grew  month  by  month,  being  nearly  $80,000,000  in  October  alone.  For 
the  year  1915  the  excess  of  gold  imports  amounted  to  $420,500,000. 

Restriction  of  International  Trade.  —  In  ancient  times  among 
many  nations,  such  as  the  Hebrews  and  Chinese,  contact  with 
other  peoples  was  feared  and  foreign  trade  was  practically  pro- 
hibited. In  Greece  and  Rome  the  greatest  thinkers  entertained 
a  profound  contempt  for  trade,  based  in  part  upon  the  belief 
that  in  exchange  one  party  is  usually  cheated ;  and  this  prejudice 
was  partially  justified  by  the  character  of  the  primitive  trader, 
who  was  part  sailor,  part  pirate,  part  merchant,  and  took  all 
the  profit  he  could  possibly  extort  in  every  transaction  as  in- 
surance against  the  great  risks  of  his  calling. 

At  a  later  date,  in  the  Middle  Ages,  when  commerce  between 
the  semi-independent  cities  of  western  Europe  increased,  trade 
came  to  be  highly  prized  by  the  average  citizen,  although  it  was 
still  condemned  by  the  philosophic  schoolmen ;  and  it  was 
regulated  in  the  most  exclusive  spirit. 

"Every  effort  was  made  to  keep  trade  as  much  as  possible  in  the  hands 
of  native  citizens.  For  example,  the  Venetians  forbade  the  Germans  from 
engaging  in  trade  with  the  East  by  way  of  Venice,  and  the  citizens  of  Ltibeck 
strove  to  keep  the  Baltic  trade  from  the  Dutch.  .  .  .  Foreigners  were 
mistrusted  and  partnerships  with  them  were  forbidden.  Foreign  visitors 
were  restricted  in  many  ways  in  their  commercial  dealings  with  native  citi- 


INTERNATIONAL   TRADE  359 

zens.  Many  occupations  were  closed  to  them;  the  length  of  their  sojourn 
and  the  number  of  their  visits  were  limited ;  they  could  not  pass  a  town  with- 
out exposing  their  wares  for  sale  and  paying  the  required  market  dues.  The 
wants  of  the  consumer  took  precedence  over  those  of  the  producer  or  mer- 
chant. At  the  weekly  markets  consumers  could  supply  their  needs  before 
the  baker  or  merchant  was  allowed  to  make  purchases.  There  was  a  com- 
munity interest  in  the  supplies  of  necessities,  and  often  their  exportation 
was  prohibited.  The  trade  of  neighboring  peasants  was  restricted  to  the 
home  city,  and  laws  regulating  price,  weight,  measure,  and  quality  were 
common.  This  restrictive  municipal  policy  was  very  much  relaxed  at  the 
great  fairs  which  were  held  periodically  in  various  parts  of  Europe."  1 

In  the  eaily  modern  period  Mercantilism  became  dominant. 
Commercial  policies  were  controlled  by  the  desire  to  get  and  keep 
the  precious  metals.  At  first  the  exportation  of  specie  was  pro- 
hibited ;  merchants  trading  abroad  were  compelled  to  bring 
home  cash  for  the  goods  they  had  taken  out  with  them  ;  foreign 
merchants  trading  within  the  home  country  were  compelled  to 
exchange  their  cash  for  domestic  goods  before  they  departed ; 
exportation  —  except  the  exportation  of  raw  materials  needed 
in  the  manufacturing  industries  —  was  encouraged ;  and  impor- 
tation —  except  in  the  case  of  the  precious  metals  and  the  skilled 
artisans  who  were  encouraged  to  immigrate  —  was  discouraged 
or  prohibited.  When  it  became  apparent  that  the  supply  of 
money  had  to  be  secured  through  international  trading,  the 
greatest  emphasis  came  to  be  laid  upon  the  "  favorable  balance 
of  trade  " ;  and  means,  ranging  all  the  way  from  bounties  to 
war,  were  vigorously  employed  to  secure  the  carrying  trade  for 
native  ships. 

Much  mercantilistic  legislation  was  immoderate,  some  of 
it  barbarous,  most  of  it  marked  by  short-sighted  national 
jealousy.  Adam  Smith  has  held  it  up  to  scorn.  Some  later 
writers  have  defended  it  as  in  the  main  necessary.  No  verdict 
on  the  subject  needs  to  be  given  here.  It  accompanied  the  weld- 
ing of  the  great  modern  states;  and  the  consolidation  of  the 
smaller  autonomies  probably  removed  more  restriction  and 
more  petty  mercantilism  than  the  new  consolidation  called 
into  being. 

1  G.  M.  Fisk,  International  Commercial  Policies,  pp.  15,  16, 


3bO  OUTLINES  OF  ECONOMICS 

In  a  large  historical  sense  Mercantilism  was  merely  a  cry 
elicited  by  one  of  the  sharpest  of  the  world's  great  growing  pains. 
It  was  a  symptom  more  than  a  cause  or  an  explanation.  It 
marked  the  establishment  of  the  division  of  labor  on  a  territorial 
basis,  and  recorded  the  replacement  of  the  independent  economy 
of  the  Middle  Ages  by  the  modern  economy  of  exchange.  For 
the  latter,  money  was  indispensable,  and  had  to  be  secured  at 
any  cost. 

The  mercantilist  period  has  been  followed  —  after  a  brief 
laissez-faire  reaction  in  some  countries  —  by  the  period  of  pro- 
tection in  which  we  still  linger.  The  extensive  taxation  of  im- 
ports still  continues;  but  trade  prohibitions  and  export  and 
transit  duties  have  been  largely  abandoned  in  the  more  advanced 
countries.  In  the  United  States  export  duties  are  prohibited  by 
constitutional  law.  But  few  nations  have  wholly  risen  above 
mercantilist  practices.  Canada  prohibits  the  importation  of 
oleomargarine  and  similar  substitutes  for  butter ;  Great  Britain 
prohibits  the  importation  of  sugar  from  countries  paying 
bounties  on  its  production ;  Switzerland  levies  an  export  tax 
on  cattle,  hides,  and  skins  shipped  from  the  country;  Norway 
and  Sweden  tax  the  exportation  of  timber;  and  Russia  still 
attempts  to  control  the  Persian  trade  by  levying  transit  duties 
upon  goods  passing  through  her  territories  destined  for  Persia. 
But  export  and  transit  duties  in  their  old  mercantilist  uses  have 
nearly  disappeared. 

Extensive  use  is  still  made  of  export  taxes  for  revenue  purposes  in  South 
America  and  the  Orient;  and  trade  prohibitions  based  upon  grounds  of 
sanitation,  morals,  and  what  is  generally  called  the  "police  power,"  are  in- 
creasing rather  than  decreasing.  Turkey,  for  instance,  levies  an  ad  valorem 
tax  of  i  per  cent  upon  all  exports;  and  in  general  the  most  important 
tropical  products  are  still  subject  to  export  taxes.  As  for  trade  prohibitions 
the  continued  necessity  for  their  occasional  employment  is  illustrated  by  our 
federal  law  authorizing  the  President  to  suspend  the  importation  of  any 
article  which  he  regards  as  "dangerous  to  the  health  or  welfare  of  the  people 
of  the  United  States."  » 

1  For  a  more  complete  enumeration  of  modern  export  duties  and  trade  prohibi- 
tions, see  G.  M.  Fisk,  International  Commerkal  Policies,  Chap.  vi. 


INTERNATIONAL  TRADE  36 1 

Nature  and  Advantage  of  International  Trade.  —  It  is  obvious 
that  there  must  be  some  restriction  of  foreign  trade.  Fiscal 
necessity,  for  instance,  forces  most  countries  to  raise  a  large 
part  of  their  national  revenue  by  import  duties.  Until  a  few 
years  ago,  "  free- trade  "  England  raised  more  national  revenue 
from  customs  than  any  other  single  source  of  taxation.  Trade 
restrictions  have  existed  as  long  as  international  trade  itself, 
and  the  real  problem  is  not  whether  there  shall  be  any  restriction 
but  where  and  when  particular  varieties  of  restraint  are  justifi- 
able. To  answer  that  question  it  is  necessary  to  make  some 
examination  of  the  nature  and  advantage  of  international  trade. 

By  far  the  most  important  truth  in  this  connection  is  the 
simple  fact  that  trade  is  a  necessary  part  of  the  process  of  pro- 
duction. Production  consists  of  the  creation  of  utility.  The 
production  of  time  and  place  utility  is  the  primary  function  of 
trade.  Trade,  therefore,  is  as  beneficial,  as  truly  productive,  as 
agriculture  or  manufactures.  The  American  people  are  just  as 
truly  engaged  in  production  when  they  buy  pulp  from  Norway 
as  when  they  cut  down  their  own  spruce  trees  to  be  manufactured 
into  "  yellow  journals." 

Trade  is  not  only  productive  in  the  sense  that  it  creates 
utilities,  but  it  is  an  indispensable  part  of  the  division  of  labor. 
Men  specialize  in  the  production  of  those  things  in  which  they 
.excel.  A  manufacturer  of  shoes  may  be  a  skilled  cabinetmaker 
as  well,  but  except  for  recreation  he  will  not  make  his  own  furni- 
ture. By  specializing  in  shoes  he  can  buy  with  shoes,  or  the 
proceeds  of  their  sale,  more  and  better  furniture  than  he  could 
make  with  his  own  hands.  An  individual  who  makes  anything 
for  himself  must  figure  as  part  of  the  cost  of  production  what  his 
labor  could  be  sold  for  in  other  fields;  and  he  obviously  loses 
money  if  on  this  reckoning  the  thing  he  makes  costs  more  than 
it  could  be  bought  for  on  the  open  market.  The  same  is  true 
of  communities.  The  city  that  by  grants  of  land  or  the  remis- 
sion of  taxes  manufactures  within  its  own  borders  things  that  it 
could  buy  more  cheaply  outside,  loses  by  the  transaction.  Not 
only  individuals  but  communities  and  nations  must  specialize 
if  the  maximum  productivity  is  to  be  secured.    There  is  a 


362  OUTLINES  OF  ECONOMICS 

territorial  as  well  as  a  personal  division  of  labor,  and  trade  is 
of  the  essence  of  both. 

Exchange  remains  profitable,  even  though  one  of  the  parties 
is  superior  in  all-around  productive  efficiency.  A  good  lawyer 
may  be  able  to  do  better  work  on  the  typewriter  than  his 
typist.  But  it  will  still  pay  the  lawyer  to  specialize  in  law 
and  to  buy  the  stenographic  service  which  he  needs.  Suppose 
that  we  were  suddenly  brought  into  contact  with  a  country 
over  which  we  had  a  universal  productive  advantage.  Every- 
thing would  be  cheaper  here ;  competition  would  force  the  other 
country  to  buy  from  us  in  all  lines ;  gold  would  flow  from  that 
country  to  this ;  prices  would  fall  there  and  rise  here ;  in  time 
an  equilibrium  would  be  reached  and  the  other  country7  would 
sell  to  us  the  things  in  which  our  productive  advantages  were 
least  important.  Articles  of  export  and  import  would  sell  at 
the  same  prices  in  both  countries  except  for  the  cost  of  carriage. 
Wages  and  the  prices  of  non-transportable  commodities  might 
differ  widely  in  the  two  countries,  even  after  the  new  equilibrium 
had  been  reached.  The  question  is  not  how  much  wages  labor 
receives,  but  what  it  costs  in  money  to  produce  transportable 
goods ;  and  these  costs  may  be  identical  (transport  costs  in- 
cluded) while  wages  differ  widely,  owing  to  differences  in  the 
productive  efficiency  of  labor  in  the  two  countries.  Each 
country  manufactures  the  product  in  which  it  has  a  comparative 
advantage  and  buys  with  these  products  other  goods  which  it 
needs.  It  specializes  in  the  production  of  those  things  in  which 
the  comparative  cost  is  lowest.  This  is  the  law  of  comparative 
costs.  If  a  group  of  individuals  insist  on  making  something 
which  they  could  buy  for  less  than  it  costs  them  to  make  it  — 
counting  their  labor  as  cost  at  what  it  would  bring  in  other 
lines  of  industry  —  there  is  a  comparative  loss. 

But  what  of  the  non-transportable  goods,  —  houses  and  the 
like?  Assume  a  state  of  civilization  in  which  the  sole  articles 
of  consumption  and  production  are  flour,  cloth,  and  houses. 
Assume  that  the  United  States  produces  flour  and  houses,  buying 
its  cloth  from  England,  and  securing  by  such  specialization  or 
division  of  labor  more  cloth  than  we  could  otherwise  secure. 


INTERNATIONAL  TRADE  363 

Suppose  the  trade  in  cloth  to  be  closed  and  the  United  States 
forced  to  manufacture  the  cloth  it  needs.  Capital  and  labor 
would  be  diverted  from  the  production  of  flour  and  houses  to 
the  production  of  cloth.  More  houses  and  more  flour  would 
have  to  be  paid  for  a  given  quantity  of  cloth.  A  given  quan- 
tity of  flour  or  house  accommodation  would  buy  less  cloth  than 
formerly.  In  general  there  would  necessarily  be  less  flour, 
cloth,  and  houses  than  before ;  the  general  productivity  of  labor 
and  capital  would  be  reduced ;  and  houses  would  be  affected 
exactly  like  flour  and  cloth  by  the  lowering  in  the  general 
level  of  productivity.  Non-exportable  goods  might  be  cheap 
or  costly;  that  would  depend  upon  the  productivity  of  labor 
and  capital  in  each  country.  But  that  productivity  is  directly 
affected  by  the  productivity  of  labor  engaged  in  the  production 
of  export  goods,  and  if  the  productivity  of  the  latter  is  lowered 
the  productivity  of  the  former  will  also  be  reduced. 

The  fundamentals  of  the  problem  are  not  changed  by  the 
introduction  of  money.  When  the  importation  of  cloth  was 
stopped  England  for  a  time  would  continue  to  buy  flour ;  but, 
the  price  of  cloth  being  raised,  our  purchases  would  fall  off  at 
once ;  specie  would  move  from  England  to  this  country ;  prices 
would  rise  here  and  fall  there ;  capital  and  labor  would  be  at- 
tracted to  the  production  of  cloth  ;  wages  as  well  as  prices  would 
rise  here.  This  is  the  initial  and  obvious  effect  of  trade  restric- 
tion. For  a  time  it  raises  prices  and  money  wages  and  gives  a 
fillip  to  trade  by  making  it  profitable  to  start  a  new  industry. 
It  is  no  wonder  that  protection  is  so  popular.  It  is  an  industrial 
stimulant. 

But  the  sequel  is  different.  The  flow  of  specie  from  England 
reduces  wages  and  prices  there,  including  the  price  of  flour,  and 
in  time  England  will  be  forced  to  produce  more  flour  for  herself. 
This  means  a  stimulus  to  the  flour  industry  in  England  and  a 
corresponding  decline  of  the  flour  industry  in  this  country. 
England's  "  stimulant  "  comes  later.  Trade  restrictions  tend 
therefore,  in  the  first  instance,  to  raise  wages  and  prices  in  the 
country  imposing  them ;  but  in  the  long  run  they  produce  al- 
ternating periods  of  depression  and  activity  in  both  countries, 


364  OUTLINES  OF   ECONOMICS 

and  enable  one  country  to  injure  another  by  forcing  the  latter 
to  readjust  her  industries  and  even  to  produce  things  she  would 
prefer  to  secure  by  purchase.  Tariff  tinkering  is  one  of  the  most 
fertile  sources  of  international  friction  and  unquestionably  one 
of  the  major  provocatives  to  war. 

Up  to  this  point  our  consideration  has  been  confined  to  two 
countries  in  the  same  stage  of  development,  with  no  great  differ- 
ences in  wages  and  interest.  What  if  one  country  is  newer,  less 
exploited,  and  has  a  higher  level  of  wages  and  interest  ? 

It  will  be  noted  in  this  case  that  labor  and  capital  would  be 
migrating  from  one  to  the  other,  with  or  without  tariff  restric- 
tion. If,  however,  the  country  with  higher  wages  imposes 
a  tariff  on  cloth,  as  assumed  above,  the  migration  of  capital 
and  labor  would  be  hastened.  The  development  of  the  cloth 
industry  in  the  younger  country  would  draw  some  of  the  labor 
and  capital  previously  engaged  in  producing  cloth  in  the  older 
country.  The  subsequent  decline  of  the  flour  industry  in  the 
younger  country,  however,  would  probably  not  send  capital 
and  labor  back  to  the  old,  because  there  would  be  better  op- 
portunities in  the  younger  country.  We  can  see  no  escape  from 
the  conclusion  that  trade  restrictions  of  this  kind  do  tend  to 
hasten  migration  to  the  country  where  real  wages  are  on  the 
higher  level.  The  effect  of  such  migration  is  curious  and  inter- 
esting. Many  writers  hold  that  it  does  not  permanently  in- 
crease the  population  of  the  newer  country,  but  merely  substi- 
tutes immigrants  and  their  offspring  for  descendents  of  the  older 
pioneers ;  while  in  the  older  country  population  is  not  reduced 
owing  to  the  infinite  expansibility  of  the  labor  supply  within 
the  limits  determined  by  the  accustomed  standard  of  living. 
But  these  phenomena  need  not  be  considered  here.  Whatever 
happens  will  be  due  chiefly  to  the  fact  that  real  wages  and  in- 
come are  higher  in  the  one  country  than  in  the  other.  Tariff 
restrictions  exercise  only  a  minor  influence  in  this  connection. 

What  if  the  older  country  had  a  positive  tariff  policy,  with 
import  duties  on  some  products,  when  the  new  country  was  dis- 
covered and  began  to  develop  a  foreign  trade?  In  accordance 
with  the  reciprocal  influence  upon  the  division  of  labor  noted 


INTERNATIONAL  TRADE  365 

above,  existing  trade  barriers  would  unquestionably  exercise 
an  influence,  probably  a  deleterious  influence,  upon  the  dis- 
tribution of  capital  and  labor  in  the  younger  country.  If  the 
older  country  had  heavy  import  duties  on  agricultural  products, 
the  expansion  of  agriculture  in  the  newer  country  would  be 
retarded  and  the  development  of  manufactures  stimulated. 
There  can  be  no  doubt  about  the  power  of  one  country  in- 
juriously to  affect  the  division  of  labor  in  another.  But  will  it 
pay  the  younger  country  to  adopt  countervailing  or  retaliatory 
duties  ?  Can  it  secure  the  ideally  perfect  distribution  of  labor 
and  capital  by  retaliatory  restrictions? 

In  theory  this  is  partially  possible.  Revert  to  the  illustration 
in  which  under  normal  conditions  the  younger  country  would 
produce  flour,  the  older  country  cloth,  and  both  countries  houses. 
Suppose  the  older  country  to  place  a  tariff  on  flour  so  that  more 
flour  and  less  cloth  would  be  produced  there.  In  all  prob- 
ability the  older  country  would  be  forced  to  continue  the  im- 
portation of  some  of  the  flour  which  it  consumed.  Under  this 
hypothesis  the  younger  country  could  set  in  motion  partially 
corrective  forces  by  placing  an  export  duty  on  the  shipment  of 
flour,  by  giving  a  bounty  on  the  production  of  flour,  or  by 
levying  an  excise  duty  on  the  production  of  cloth  within  its 
borders.  It  is  interesting  to  note  in  this  connection  that 
England,  in  order  to  counteract  the  protective  influence  of  the 
import  duties  which  fiscal  necessity  forces  her  to  use,  imposes 
an  excise  duty  of  equivalent  burden  on  the  same  goods  produced 
within  her  border,  thus  counteracting  as  far  as  possible  any  in- 
fluence which  the  import  duties  might  otherwise  exercise  on 
production. 

In  practice,  however,  such  corrective  measures  are  nearly 
useless.  No  country  knows  what  the  ideal  or  normal  division' 
of  labor  for  her  would  be.  Moreover,  export  duties  and  boun- 
ties are  costly  to  administer  and  liable  to  abuse.  Conceivably, 
of  course,  trade  interference  by  one  country  may  become  so 
unreasonable,  so  unsettling,  so  capriciously  injurious,  that  other 
countries  may  be  forced  to  protect  themselves.  For  instance, 
one  country  may  deliberately  adopt  the  policy  —  by  giving 


366  OUTLINES  OF   ECONOMICS 

bounties  or  preferential  freight  charges  and  the  like  —  of  pre- 
venting the  development  in  another  country  of  an  industry  in 
which  the  former  is  specially  interested.  Under  such  circum- 
stances other  countries  may  be  justified  in  protecting  an  estab- 
lished industry  by  the  necessary  retaliatory  legislation. 

The  general  political  and  social  aspects  of  protection  are  dis- 
cussed in  the  next  chapter.  They  furnish,  as  will  be  seen,  some 
theoretical  justification  for  trade  restriction.  Surveyed  as  a 
purely  commercial  question  of  dollars  and  cents,  however,  the 
profitableness  of  the  unregulated  territorial  division  of  labor  is 
beyond  all  question  of  doubt,  in  the  opinion  of  the  authors; 
and  the  history  of  international  trade  fully  confirms  the  bald 
theory  here  outlined.  That  theory  has  been  exposed  to  the 
most  searching  practical  test  to  which  any  economic  theory 
could  be  subjected,  and  it  meets  the  test  successfully.  If  the 
theory  of  comparative  costs  is  correct,  it  follows  that  so  long  as 
the  comparative  costs  of  producing  goods  vary  among  the 
different  nations  of  the  world,  so  long  there  will  be  some  inter- 
national trade.  Furthermore,  since  it  is  impossible  to  conceive 
that  the  costs  of  producing  all  kinds  of  transportable  goods  will 
ever  be  exactly  proportional  in  the  several  countries  of  the  world, 
it  is  evident  that  international  trading  is  bound  to  continue. 
International  trade  can  be  permanently  suppressed  only  by 
raising  freight  charges  to  prohibitive  level,  or  by  deliberately 
manipulating  tariffs  so  as  to  suppress  every  new  international 
trade  connection  as  soon  as  it  springs  up,  or  by  the  complete 
destruction  of  industry  in  other  parts  of  the  world.  According 
to  theory,  then,  international  trade  is  for  practical  purposes 
irrepressible  and  the  ideal  of  an  exclusive  home  market  is  a 
delusion. 

This  theory,  as  stated  above,  has  been  subjected  to  the  most 
searching  test.  During  the  last  fifty  years  trade  restriction  has 
been  piled  on  trade  restriction  and  protective  tariff  walls  have 
been  built  higher  and  higher.  But  there  has  been  no  diminution 
in  international  trade.  On  the  contrary,  it  has  increased  and 
developed  by  leaps  and  bounds. 


INTERNATIONAL   TRADE  367 

QUESTIONS 

1.  In  what  respects  does  foreign  exchange  differ  from  exchange  between 
two  American  cities? 

2.  What  are  the  principal  influences  which  affect  the  rate  of  exchange? 

3.  Is  the  gold  supply  distributed  according  to  the  needs  or  the  respective 
demands  of  the  various  countries?  Are  needs  and  demands  in  this  connec- 
tion identical? 

4.  Mention  as  many  methods  as  you  can  by  which  governments  have 
endeavored  to  increase  the  supply  of  gold. 

5.  What  is  meant  by  the  law  of  comparative  costs?  Is  the  American 
custom  of  importing  the  finer  textile  fabrics  and  manufacturing  the  coarser 
ones  an  effect  of  this  law  ? 

6.  If  a  widow  needs  money  so  badly  that  she  is  willing  to  pay  200  per 
cent  a  year  for  its  use,  is  it  wrong  for  a  money  lender  to  charge  this  rate? 

7.  What  is  the  real  nature  of  the  balance  of  trade?  Does  our  excess  of 
exports  (merchandise)  mean  that  we  are  paying  off  our  foreign  indebtedness, 
or  merely  that  we  are  paying  interest  on  our  foreign  indebtedness? 

REFERENCES 

Bastable,  C.  F.     Theory  of  I ntcr national  Trade. 

Brown,  H.  G.     Internationa!  Trade  and  Exchange. 

Clare,  George.     The  ABC  of  the  Foreign  Exchanges ;    The  Money  Market 

Primer. 
Escher,  Franklin.     Elements  of  Foreign  Exchange. 
Fisk,  G.  M.     International  Commercial  Policies. 
Giffen,  Robert.     "The  Use  of  Export  and  Import  Statistics,"  in  Economic 

Inquiries  and  Studies,  Vol.  i,  Chap.  ix. 
Goschen,  G.  J.     Theory  of  the  Foreign  Exchanges. 
Laughlin,  J.  L.     The  Principles  of  Money,  Chap.  x. 
Margraff,  A.  W.     International  Exchange. 

Mill.  J.  S.     Principles  of  Political  Economy,  Book  iii,  Chs.  xvii-xx. 
Spalding,  W.  F.     Foreign  Exchange  and  Foreign  Bills. 
Taussig,  F.  W.    Some  Aspects  of  the  Tariff  Question,  Part  i. 
Withers,  Hartley.    Money  Changing. 


CHAPTER  XVIII 
PROTECTION  AND  FREE  TRADE 

We  are  now  in  a  position  to  review  intelligently  the  pros  and 
cons  of  the  modern  tariff  controversy.  Because  of  the  limita- 
tions of  space,  the  discussion  will  be  confined  almost  wholly 
to  American  conditions,  although  most  of  the  arguments  are 
applicable  to  other  countries  as  well. 

The  Case  for  Protection.  —  i.  One  of  the  most  captivating  ar- 
guments for  protection  is  the  assertion  that  it  promotes  national- 
ism, which  is  held  to  be  a  good  thing.  Domestic  trade,  it  is 
claimed,  draws  the  citizens  of  a  country  together,  while  interna- 
tional trade  is  cosmopolitan  and  tends  to  their  separation. 
Upon  the  creation  of  our  federal  government,  state  tariffs 
were  abolished  and  their  place  taken  by  a  national  tariff  designed 
partly  to  protect  the  whole  of  the  country  against  the  rest  of 
the  world.  The  introduction  of  national  protection  thus  went 
hand  in  hand  with  the  promotion  of  internal  free  trade ;  and 
Professor  Schmoller  even  maintains  the  general  thesis  that, 
historically,  this  double  process  of  internal  abolition  and  external 
extension  of  tariffs  marks  the  formation  of  new  states,  partic- 
ularly federal  states.  Protection  against  foreign  competition, 
he  asserts,  is  thus  historically  coincident  with  the  enfranchise- 
ment of  internal  trade ;  and  has  as  its  main  object  the  creation 
of  a  strong  national  economic  unity,  without  which  permanent 
political  unity,  he  thinks,  is  impossible.  The  validity  of  this 
argument,  it  will  be  noted,  depends  largely  upon  the  truth  of 
the  assumption  that  the  development  of  a  strong  feeling  of 
national  unity  is  a  thing  to  be  desired. 

2.  Government  should,  the  protectionists  say,  foster  infant 
industries  in  order  to  develop  our  natural  resources  and  to  pro- 

368 


PROTECTION  AND    FREE   TRADE  369 

duce  diversity  in  industrial  pursuits.  It  is  admitted  that  pro- 
tection is  temporarily  expensive,  but  so  is  the  prohibition  of 
child  labor  temporarily  expensive.  We  prevent  children  from 
earning  a  little  while  they  are  young  in  order  that  they  may  earn 
more  when  they  are  old.  For  the  same  reasons  trade  unions 
rightfully  insist  that  apprentices  shall  be  given  a  broad  knowl- 
edge of  the  trade  they  are  learning,  although  it  is  more  profit- 
able for  the  employer  to  have  them  specialize  early  in  some 
narrow  branch  of  the  work.  So,  similarly,  protection  prevents  a 
nation  from  specializing  too  exclusively  in  its  undeveloped  stage, 
in  order  that  it  may  the  sooner  arrive  at  industrial  manhood. 

Economists  have  generally  admitted  that  there  is  a  certain 
amount  of  truth  in  this  argument.  If  an  industry  gets  an  early 
start  in  a  given  district,  this  locality  is  likely  to  retain  its  advan- 
tage because  of  the  concentration  there  of  capital  and  labor  ac- 
quainted with  the  requirements  and  possibilities  of  the  industry. 
Thus  63.3  per  cent  of  all  the  needles,  pens,  hooks  and  eyes,  manu- 
factured in  this  country  are  made  in  Connecticut,  for  no  other 
reasons  that  one  can  see  than  those  suggested  in  the  explana- 
tory phrase  —  "  the  momentum  acquired  by  an  early  start." 
And  this  localization  of  industry  is  artificially  fostered  by  the 
practice,  common  to  exporters  all  over  the  world,  of  selling 
abroad  more  cheaply  than  at  home.  The  export  trade  seems 
to  be  universally  coddled.  Of  course,  such  localized  industries 
can  be  maintained  only  when  the  cost  of  transporting  the  article 
is  small ;  and  when  other  districts  do  not  possess  unusual 
natural  advantages  in  the  way  of  accessibility  to  superior  raw 
material,  power,  or  skilled  labor.  The  census  studies  in  the  lo- 
calization of  domestic  industries  l  seem  to  indicate  that  while 
the  industrial  inertia  of  which  we  have  been  speaking  is  an  im- 
portant factor,  it  is  not  so  important  as  the  opposing  forces 
making  for  territorial  diffusion  of  industry. 

A  most  interesting  illustration  of  an  attempt  to  crush  the  "infant  indus- 
tries" of  a  competing  nation  is  found  in  the  effort  of  English  manufacturers 

1  Special  Census  Report,  Manufactures,  1005,  Part  i,  p.  cclx.  Cf.  also,  Twelfth 
Census,  Manufactures,  Part  i,  pp.  cclx-ccxiv;  and  Thirteenth  Census,  Vol.  viii, 
Chap.  vii. 


370  OUTLINES   OF  ECONOMICS 

after  the  War  of  1812,  to  recover  the  American  market  of  which  they  had 
been  temporarily  deprived  by  the  long  period  of  nonintercourse.  "  English 
manufacturers,  eager  to  regain  control  of  the  lost  markets,  sent  in  ship- 
loads of  cotton  and  woolens  and  iron  manufactures,  which  they  offered  on 
the  most  liberal  terms  to  their  agents  in  this  country.  The  goods  were 
taken  on  credit  and  disposed  of  at  auction.  The  object  was  to  undersell 
at  any  cost,  and  thus  break  down  the  infant  industries.  Lord  Brougham 
justified  the  speculative  character  of  this  trade  on  the  ground  that  'it  was 
well  worth  while  to  incur  a  loss  upon  the  first  exportation,  in  order,  by  the 
glut,  to  stifle  in  the  cradle  those  rising  manufactures  in  the  United  States 
which  the  war  had  forced  into  existence  contrary  to  the  natural  course  of 
things.'"  1 

3.  Closely  connected  with  the  preceding  arguments  is  a  de- 
fense of  protection  based  upon  grounds  of  war  and  military 
necessity.  Industrial  independence,  it  is  asserted,  prepares  a 
nation  better  for  international  war.  There  is  unquestionably  a 
great  deal  of  truth  in  the  argument.  Germany  has  deliberately 
used  protective  tariffs  to  preserve  herself  at  least  in  part  as  an 
Agrarstaat,  and  there  has  already  been  striking  evidence  of  the 
wisdom  of  her  policy  of  maintaining  a  large  measure  of  economic 
self-sufficiency.  Certainly  a  wise  nation  will  see  to  it  that  within 
its  boundaries  factories  exist  which  can  manufacture  arms  and 
all  the  necessary  munitions  of  war.  Success  in  war  is  not  de- 
pendent upon  arms  and  ammunitions  alone.  There  must  be  a 
plentiful  supply  of  money,  and  whatever  use  may  be  made  of 
credit,  enormous  amounts  of  money  must  be  raised  by  taxation.2 
The  source  of  taxation  is  a  flourishing  condition  of  private  in- 
dustry; and  the  industry  of  the  average  nation  dependent 
upon  international  trade  cannot  flourish  in  times  of  war.  But 
even  the  ability  to  secure  public  revenues  in  adequate  quantities 
is  less  important  in  time  of  war  than  the  ability  of  a  nation  to 
feed  and  clothe  its  people  and  its  armies  when  international  trade 
is  suddenly  cut  off.  The  failure  of  the  South  in  the  Civil  War 
was  very  largely  due  to  her  industrial  dependence  upon  the 
cotton  export  trade.     A  sufficient  diversification  of  industry  to 

1  Coman,  Industrial  History  of  the  United  States,  p.  185. 

'  For  a  classic  explanation  of  the  dependence  of  both  public  credit  and  taxation 
upon  a  nourishing  condition  of  private  business  in  times  of  war,  see  Henry  C.  Adams, 
Public  Debts. 


PROTECTION  AND   FREE   TRADE  37 1 

prevent  industrial  paralysis  and  to  insure  an  adequate  supply 
of  the  necessaries  of  life  in  times  of  war  is,  we  believe,  mani- 
festly desirable. 

4.  The  home  market  argument  for  protection  naturally  follows. 
Much  that  is  said  in  defense  of  this  claim  is  childish  or  silly. 
One  distinguished  American  economist  seriously  maintained 
that  a  country  can  remain  permanently  prosperous  only  on 
condition  that  what  is  taken  from  the  soil  shall  be  returned  in 
manure  and  other  kinds  of  fertilizers,  and  that  this  will  be  ac- 
complished only  when  the  products  of  the  soil  are  consumed 
at  home.  A  much  stronger  application  of  the  argument,  how- 
ever, is  found  in  the  assertion  that  the  home  market  is  superior 
because  it  is  a  surer  market.  A  foreign  market,  is  usually  a  pre- 
carious market.  It  is  likely  to  be  closed  by  war  or  by  capricious 
changes  in  tariff  policy.  Protection  is  unquestionably  expen- 
sive to  the  country  that  protects,  but  in  the  long  run  it  is  worth 
paying  something  to  keep  industries  in  continuous  operation. 

5.  This  brings  us  to  the  argument  for  protection  as  a  defense 
against  "  dumping."  By  dumping  is  meant  the  sale  of  products 
abroad  at  prices  lower  than  those  charged  at  home.  Dumping 
arises  in  a  variety  of  ways.  Export  bounties  may  be  granted 
by  the  home  country  for  the  specific  purpose  of  encouraging 
foreign  trade ;  or  a  monopoly  may  find  it  profitable  to  dispose  of 
a  surplus  abroad  at  prices  which  would  be  needlessly  low  in  the 
highly  protected  home  country;  or  manufactures  may  avail 
themselves  of  the  difference  between  fixed  and  variable  expenses 
of  production  to  secure  some  profits  over  the  specific  or  variable 
expenses  of  production  by  selling  abroad  at  prices  which  would 
not  be  remunerative  if  applied  to  their  entire  output.  More- 
over, there  is  good  reason  to  believe  that  many  manufacturers  for 
the  export  trade  make  it  a  practice  to  sell  abroad  at  unusually 
low  prices  whenever  they  believe  that  their  foreign  market  is 
threatened.  As  was  stated  above,  the  custom  of  "  coddling  " 
the  export  trade  seems  to  be  very  general. 

Now  if  the  reduction  of  prices  were  permanent,  the  country 
in  which  the  products  are  dumped  would  have  no  real  cause  for 
complaint.     On  the  contrary,  it  might  logically  regard  itself  as 


372  OUTLINES  OF  ECONOMICS 

the  beneficiary  of  the  costly  bounties  of  the  other  nation.  But 
real  dumping  is  not,  and  in  the  nature  of  things  cannot  be, 
permanent.  So  far  as  it  may  be  said  to  have  a  rational  object, 
it  aims  to  secure  foreign  markets  by  selling  temporarily  at  prices 
which  in  the  long  run  would  not  be  profitable ;  and  when  the 
market  is  secured,  prices  will  be  iaised.  So  true  is  this  that 
economists  have  generally  indorsed  import  taxes  and  other  tem- 
perate retaliatory  measures  designed  to  abolish  dumping. 
Canada,  for  instance,  has  authorized  the  levy  in  such  cases  of  a 
special  dumping  duty  "  equal  to  the  difference  between  the 
selling  price  of  the  article  for  export  and  the  fair  market  value 
thereof  for  home  consumption."  A  few  years  ago  the  beet- 
sugar  industry  of  France  and  Germany  was  so  stimulated  by 
bounties  that  even  England,  the  principal  dumping  ground 
of  the  product,  was  forced  to  threaten  reprisals  in  the  shape  of 
countervailing  import  duties.  England's  resolute  attitude,  it 
may  be  added,  led  finally  to  the  virtual  abolition  of  sugar 
bounties  at  the  International  Sugar  Conference  of  1903.  In 
general,  there  seems  to  be  ample  justification  for  protective 
duties  that  are  honestly  used  to  ward  off  destructive  attacks  upon 
home  industries  which,  if  subjected  only  to  legitimate  competi- 
tion, would  be  able  to  maintain  themselves  in  the  long  run.  It 
is  evident  that  we  have  here  returned  to  the  substratum  of  truth 
contained  in  the  infant  industry  and  home  market  arguments. 

Dumping  has  been  more  productive  of  arguments  against  protection  than 
of  arguments  for  protection,  in  the  United  States;  and  the  opponents  of  pro- 
tection have  laid  great  emphasis  upon  the  fact  that  many  articles  of  Ameri- 
can manufacture  are  sold  abroad  more  cheaply  than  at  home.  That  this  is 
a  fact  is  now  generally  admitted.  But  the  protectionists  maintain  that 
most  of  this  can  be  explained  by  the  rebates  allowed  to  American  exporters 
under  our  drawback  laws.  Ex-Secretary  of  the  Treasury  Shaw  estimates 
that  in  1906,  owing  to  these  drawbacks,  about  $140,000,000  of  American 
manufactures  might  have  been  legitimately  sold  abroad  at  less  than  domestic 
prices.1 

6.  Intimately  related  to  the  arguments  which  we  have  been 
considering  is  the  claim  that  the  utilization  of  labor  and  capital 

1  Leslie  M.  Shaw,  Current  Issues,  ChaD.  xri. 


PROTECTION  AND  FREE  TRADE         373 

of  a  free-trade  nation  is  subject  to  the  control,  and  indeed,  one 
may  say,  to  the  whim  and  caprice  of  foreign  nations.  Industries 
differ  in  their  effect  upon  the  physique  and  character  of  the 
people  who  pursue  them.  The  builder,  the  skilled  engineer,  the 
electrical  worker,  are  benefited  intellectually,  physically,  and 
morally  by  their  occupations.  But  the  tailor,  the  maker  of 
ready-made  clothing,  and  the  sweat-shop  worker  are  probably 
harmed  rather  than  elevated  by  the  nature  of  their  employment. 
Now  if  foreign  nations  subsidize  by  protection  and  bounty  the 
desirable  industries,  they  may  leave  to  the  free-trade  nation 
only  those  industries  which  the  protected  nations  do  not  wish 
to  maintain. 

7.  Finally,  protectionists  appeal  to  the  wage-earning  classes 
with  the  argument  that  protection  increases  wages  by  diversify- 
ing industry  and  thus  stimulating  the  demand  for  labor.  Indeed 
the  typical  protectionist  goes  farther  than  this,  and  maintains 
that  every  American  industry  is  entitled  to  an  amount  of  pro- 
tection equal  to  the  difference  between  the  wages  which  it  pays 
and  the  wages  paid  by  its  most  efficient  foreign  competitor.  The 
latter  variety  of  this  argument  seems  to  be  plainly  absurd,  or  at 
least  obviously  inconsistent  with  the  initial  assertion  that  pro- 
tection raises  wages.  For,  taken  together  —  and  they  are 
frequently  advanced  in  company  —  they  result  in  this  magnifi- 
cently cumulative  plea  for  ever  increasing  tariffs :  protection 
raises  wages  —  but  high  wages  put  the  American  manufacturer 
at  a  disadvantage  in  competing  with  foreign  producers  —  and 
the  home  producer  must  be  protected  to  the  extent  of  the  differ- 
ence in  wages  —  therefore  every  advance  in  protective  duties 
laid  for  the  benefit  of  the  wage  earner  must  be  accompanied 
by  an  additional  advance  for  the  benefit  of  the  manufacturer  — 
and  so  ad  infinitum. 

8.  That  protective  duties  should  be  used  to  "  equalize  costs  of 
production  "  here  and  abroad,  has  been  widely  advocated  as 
the  modern  and  scientific  basis  of  protection.  It  would  be  hard 
to  find  a  more  unscientific  proposal.  In  the  first  place  it  is 
vague  and  uncertain.  Costs  of  production  are  not  uniform, 
either  here  or  in  foreign  countries.     What  costs  are  to  be 


374  OUTLINES  OF  ECONOMICS 

equalized  ?  —  costs  to  the  most  efficient  producer  here  and  the 
most  efficient  producer  abroad,  or  costs  to  the  "  typical  " 
producer  here  and  the  "  typical  "  producer  abroad,  or  costs  to  the 
least  efficient  producer  here  and  the  most  efficient  producer 
abroad?  In  the  second  place,  certain  costs,  such  as  rent  and 
even  wages,  are  more  or  less  dependent  upon  tariff  duties  them- 
selves, so  that  the  proposal  to  determine  duties  by  costs  merely 
get  us  into  the  vicious  circle  noted  above.  Furthermore,  there 
is  no  logical  or  natural  limit  to  this  process.  If  we  are  to  equalize 
costs  in  the  textile  and  steel  industries,  why  not  equalize  costs 
in  the  production  of  bananas,  coffee,  and  tea? 

As  a  matter  of  fact  if  this  program  could  be  carried  out  it 
would  stop  all  trade  and  so  wipe  out  the  whole  gain  from  the 
international  division  of  labor.  But  fortunately  the  program 
cannot  be  carried  out.  Economic  goods  take  on  a  thousand 
forms.  We  bar  the  importation  of  one  variety  only  to  find  an 
equivalent  exchange  springing  up  in  another  variety.  This  is 
what  we  should  expect  from  the  theory  of  international  trade, 
and  theoretical  expectations  are  amply  confirmed  by  history 
and  statistics. 

Arguments  of  Free  Traders.  —  In  the  first  place,  we  may  dis- 
miss a  number  of  arguments  which  are  so  extreme  as  to  weaken 
rather  than  strengthen  the  cause  of  free  trade. 

i.  For  instance,  it  is  frequently  alleged  that  protective 
tariffs  violate  the  assumed  natural  right  of  every  man  to 
buy  his  goods  where  he  will  and  sell  his  products  wherever 
he  sees  fit,  untrammeled  by  human  laws.  The  futility  of 
arguments  based  upon  an  assumption  of  natural  rights  has 
been  sufficiently  exposed  elsewhere,  and  needs  no  elaboration 
at  this  point. 

2.  It  has  also  been  claimed  that  protective  tariffs  in  the  United 
States  are  unconstitutional,  but  this  argument  is  idle ;  it  would 
be  most  unfortunate  and  anomalous  if  nowhere  in  our  country 
were  lodged  the  power  to  pass  such  regulations  regarding  in 
ternational  commerce  as  might  appear  to  be  required  for  the 
promotion  of  the  public  welfare.  Furthermore,  the  charge  of 
unconstitutionality  does  not  correspond  to  the  opinion  of  our 


PROTECTION  AND   FREE  TRADE  375 

best  jurists  and  there  are  no  decisions  of  the  Supreme  Court 
which  in  any  way  tend  to  support  this  claim. 

3.  In  a  similar  vein  protectionism  has  been  called  socialism, 
but  this  epithet  is  so  generally  applied  to  whatever  a  person  in- 
competent to  argue  a  cause  does  not  like  that  it  will  scarcely 
terrify  any  one. 

The  really  able  arguments  of  free  traders  are  those  which 
aim  to  show  either  that  protection  actually  does  positive  harm, 
or  that  it  fails  to  accomplish  its  ends,  or  that  those  ends  may  be 
better  accomplished  without  protection. 

1.  The  natural  starting  point  of  the  free- trade  argument,  and 
the  goal  to  which  it  inevitably  returns,  is  the  theory  of  comparative 
costs  laid  down  on  page  362,  the  proposition  that,  so  long  as 
there  are  relative,  not  necessarily  absolute,  differences  in  the  cost 
of  producing  cheaply  portable  articles  in  various  countries  of 
the  world,  so  long  will  there  be  international  trade  in  those 
articles.  Protective  tariffs,  therefore,  merely  divert  capital  and 
labor  from  intrinsically  more  productive  to  intrinsically  less  pro- 
ductive industries.  To  revert  to  our  simile  of  the  lawyer  and  his 
stenographer,  protection  aims  to  induce  the  lawyer  to  write  his 
own  letters,  on  the  general  grounds  that  lawyers  are  more  intelli- 
gent people  than  stenographers,  and  if  sufficient  encouragement 
be  held  out  to  them  they  may,  in  the  course  of  time,  be  educated 
up  to  the  point  of  operating  their  own  typewriting  machines 
better  than  the  stenographers  whom  they  have  previously  hired. 

Temperate  advocates  of  "  freer  trade  "  do  not  contend  thaC 
this  law  of  comparative  costs  demonstrates  the  desirability  of 
complete  free  trade  under  all  circumstances.  They  admit  that 
it  may  occasionally  be  profitable  for  a  country  to  pay  enormous 
bounties  —  this  is  what  protection  amounts  to  —  for  the  de- 
velopment of  certain  industries.  But  they  do  contend  that  it 
establishes  free  trade  as  the  general  rule,  every  departure  from 
which  should  require  the  most  positive  justification.  More  par- 
ticularly, they  hold,  that  at  the  present  time,  after  a  century  of 
industrial  development  that  obviates  any  military  necessity  for 
a  further  diversification  of  industry,  capital  and  labor  should  be 
freely  allowed  to  take  themselves  to  those  employments  in 


376  OUTLINES   OF  ECONOMICS 

which  they  can  reap  the  largest  natural  reward,  a  reward,  that  is 
to  say,  which  is  not  artificially  enhanced  by  subsidies  wrung  from 
the  general  body  of  consumers. 

2.  Moreover,  it  is  not  clear  that  protection  is  necessary  to 
diversify  industry  in  a  country  with  such  varied  natural  resources 
as  the  United  States.  The  claims  of  the  protectionists  at  this 
point  may  be  tested  by  examining  conditions  within  the  wide 
borders  of  our  own  country,  within  which  trade  is  wholly  free. 
Now,  if  protection  were  necessary  to  foster  infant  industries 
and  bring  them  to  maturity,  the  manufacturing  industries  of  this 
country  would  still  be  concentrated  in  the  northern  states  of 
the  Atlantic  seaboard  where  they  first  gained  a  foothold.  But 
they  have  not  been  so  confined.  The  early  establishment  of  the 
textile  industries  in  New  England  has  not  prevented  their  recent 
development  in  the  South.  Indeed,  the  so-called  "  center  of 
manufactures  "  moved  steadily  west  from  south-central  Pennsyl- 
vania in  1850  to  central  Ohio  in  1900;  and  the  increase,  at  the 
present  time,  is  much  more  rapid  in  the  South  and  West  than 
in  the  older  sections  of  the  country.  Internal  free  trade  has  not 
prevented  the  diversification  of  industry  in  the  United  States, 
and  has  not  delayed  it  longer  than  was  desirable.  For  who  shall 
say  that  the  Dakotas  and  other  typical  agricultural  states  of  the 
Union  have  greatly  suffered  from  the  absence  of  grimy  factory 
towns  ? 

3.  The  inevitable  spread  of  manufactures  throughout  the 
United  States  suggests  the  essential  weakness  of  the  home 
market  argument.  International  trade  expands  just  as  inevitably 
as  the  manufacturing  area.  It  might  be  desirable  to  confine 
domestic  producers  to  the  more  certain  home  market,  which 
cannot  be  destroyed  by  tariff  wars  or  international  complications. 
But,  as  a  matter  of  fact,  home  products  will  seek  foreign  markets, 
and  the  nation  that  sells  abroad  must  buy  abroad.  Since  the 
Civil  War  we  have  protected  home  producers  with  extremely 
high  tariffs.  But  in  the  last  thirty  years  our  foreign  trade  has 
increased  at  a  rate  unequaled  by  any  of  the  other  great  commer- 
cial countries  of  the  world.1     Protective  tariffs  can  cripple  and 

1  Special  Reports  of  the  Census  Office,  Manufactures,  1905,  Part  i,  p.  ccc. 


PROTECTION  AND  FREE  TRADE         377 

harass  and  distract  foreign  trade,  but  they  cannot  permanently 
suppress  it.  No  tariff  can  make  the  costs  of  producing  all  the 
articles  common  to  commerce  precisely  proportional  in  all 
quarters  of  the  globe. 

4.  The  protectionists  appeal  to  the  wage  earner  seems  par- 
ticularly inconclusive.  One  reason  for  distrusting  it  is  the 
double-faced  way  in  which  it  is  manipulated  to  suit  the  partic- 
ular requirements  of  time  and  place.  France  wants  protection 
in  order  to  protect  her  low-paid  workmen  against  the  greater 
skill  and  efficiency  of  America's  highly  paid  workers.  The 
United  States,  on  the  other  hand,  must  have  protection  in  order 
to  shield  her  highly  paid  employees  from  competition  with  the 
"  pauper  labor  of  Europe."  When  first  used  in  the  United  States 
the  argument  was  that  wages  were  already  so  high  in  this  country 
as  compared  with  England,  that  it  was  impossible  for  manufac- 
turers in  this  country  to  pay  the  American  rates  and  continue 
to  compete  with  English  manufacturers.  Later,  cause  and 
effect,  as  related  in  the  earlier  syllogism,  were  reversed,  and  it 
was  asserted  that  the  high  wages  in  this  country  were  due  to 
protection,  from  which  it  followed  naturally  that  in  order  to 
raise  wages  higher,  still  more  protection  would  have  to  be  given. 

We  cannot  arrive  at  any  useful  conclusions  concerning  wages, 
however,  without  considering  the  efficiency  of  labor  and  the  pro- 
ductivity or  favorableness  of  the  environment  in  which  the 
laborer  works.  The  reason  why  American  labor  may  receive 
higher  wages  and  yet  have  nothing  to  fear  from  the  competition 
of  less  highly  paid  workmen  in  Europe  is  found  in  the  great  pro- 
ductivity of  American  labor  (though  this  greater  productivity 
may  depend  more  upon  the  natural  wealth  of  this  country  than 
upon  any  innate  technical  superiority  of  the  American  workmen). 
The  average  American  workman  is  in  no  more  danger  from  the 
goods  produced  by  the  "  pauper  labor"  of  Europe  than  the  highly 
paid  workman  of  Montana  is  threatened  by  the  products  of  his  less 
remunerated  fellow-workmen  of  New  England  and  the  South. 
Labor  competes  with  labor,  not  with  commodities.  Conse- 
quently, if  it  is  really  desired  to  protect  labor,  the  logical  way 
would  be  to  place  a  tax  on  imported  labor,  or  by  other  measures 


378  OUTLINES   OF   ECONOMICS 

to  reduce  immigration.  If  this  were  done,  those  who  desire  labor 
would  be  obliged  to  pay  heavily  for  it,  as  actually  happened  in 
England  after  the  "  Black  Death  "  in  the  fourteenth  century  had 
killed  off  a  large  part  of  the  laboring  population.  Indeed,  if  our 
tariff  makers  are  sincerely  anxious  to  benefit  labor,  they  should, 
after  rendering  labor  scarce  and  dear  by  restricting  immigration, 
encourage  the  importation  of  such  commodities  as  are  consumed 
primarily  by  wage  earners,  in  order  that  labor  may  secure  an 
abundance  of  them  cheaply. 

No  intelligent  free  trader  would  deny  that  there  are  now  dependent  upon 
protection  many  industries  which  pay  high  wages,  nor  that  the  sudden  aboli- 
tion of  protection  would  throw  many  wage  earners  out  of  work.  Their  con- 
tention in  the  first  case  is  merely  that  by  taxation  and  by  diverting  capital 
and  labor  into  naturally  unproductive  industries,  protection  lowers  the  gen- 
eral level  of  real  wages.  Their  reply  to  the  second  point  is  that  protection 
affects  the  industrial  organism  much  as  the  alcoholic  habit  affects  the  human 
organism.  To  abandon  the  habit  suddenly  would  certainly  be  painful  and 
probably  dangerous  —  but  this  is  sufficient  reason  neither  for  increasing 
the  dram  nor  delaying  the  gradual  abandonment  of  the  habit. 

5.  Turning  to  the  fiscal  aspects  of  the  question,  the  free  trader 
asserts  that  there  is  little  or  nothing  to  be  said  in  favor  of  protec- 
tion. The  protective  import  duty,  as  compared  with  the  import 
duty  "  for  revenue  only,"  is  a  poor  tax.  It  is  uncertain  and 
viciously  variable,  and  in  the  great  majority  of  cases  is  borne 
by  the  home  consumer.  To  the  extent  that  it  does  not  prevent 
importation  it  affords  no  protection;  and  in  so  far  as  it  does 
protect,  it  yields  no  revenue  to  the  government.  If  it  raises  the 
price  of  the  article  upon  which  it  is  levied,  however,  the  increase 
constitutes  a  tax  upon  one  class  of  society  —  the  consumer  — 
for  the  benefit  of  another  class  —  the  producers  of  the  article. 
One  authority,  perhaps  the  foremost  authority,  upon  the  Ameri- 
can tariff  problem,  estimates  that  the  tariff  upon  sugar  imposed 
by  the  Payne-Aldrich  Act  of  1909  resulted  in  an  annual  tax 
upon  American  consumers  of  $101,000,000,  of  which  $52,400,000 
went  into  the  treasury  and  $48,600,000  into  the  hands  of  sugar 
producers  principally  resident  in  Hawaii,  Porto  Rico,  and  Cuba.1 

1  Professor  F.  W.  Taussig,  in  the  Atlantic  Monthly,  March,  1008,  p.  342. 


PROTECTION  AND  FREE  TRADE        379 

In  answer  to  this  charge  that  protection  involves  the  taxa- 
tion of  one  class  for  the  benefit  of  another  class,  it  is  not  sufficient 
to  reply  that  everybody  is  free  to  take  advantage  of  the  subsidy 
and  engage  in  a  protected  industry.  Everybody  is  not  free  to 
establish  a  rolling  mill  or  a  silk  factory  or  a  tin-plate  plant. 
Protection  means  the  taxation  of  the  less  acute,  the  less  enter- 
prising, the  less  educated,  and  the  poorer  classes  in  order  to 
create  additional  commercial  opportunities  for  the  abler, 
wealthier,  and  better-educated  classes,  thus  reversing  the  whole 
spirit  of  modern  taxation  which  contemplates  —  so  far  as  it 
may  be  done  without  danger  —  rather  the  taxation  of  the  rich 
for  the  assistance  of  the  poor  than  the  taxation  of  the  poor  for 
the  benefit  of  the  rich.  It  is  not  implied,  of  course,  that  pro- 
tection involves  class  legislation  of  an  unlawful  character,  nor 
that  taxes  are  collected  from  one  class  and  handed  over  in  cold 
cash  to  the  members  of  another  class.  The  point  turns  upon 
the  relative  ability  of  the  various  social  classes  to  take  advantage 
of  artificial  opportunities  created  by  the  state  at  enormous 
expense  to  all. 

6.  This  brings  us  naturally  to  the  ethical  criticism  of  protec- 
tion, the  charge  that  by  making  the  temporary  prosperity  of 
influential  classes  dependent  upon  government  bounty,  protec- 
tion encourages  those  classes  to  exert  a  demoralizing  pressure 
upon  federal  legislation.  So  great  is  the  stake  of  private  in- 
terests in  tariff  legislation,  that  systematic  lobbying,  log  rolling, 
and  corruption  of  the  voter  follow  as  inevitable  consequences. 
The  beneficiary  of  the  tariff  sacrifices  his  disinterested  convic- 
tions concerning  the  general  welfare,  in  order  to  preserve  his  own 
little  subsidy  from  the  government.  Neither  the  citizen  nor 
the  legislator  can  vote  purely,  when  his  pocketbook  is  so  vitally 
affected.  Even  if  we  admit  what  is  probably  true,  that  protec- 
tion has  resulted  in  comparatively  little  direct  bribery  of  legis- 
lators, there  seems  no  escape  from  the  conclusion  that  it  creates 
a  kind  of  interest  in  legislation  which  is  inherently  dangerous 
and  exceedingly  difficult  to  keep  within  legitimate  bounds. 
The  weightier  arguments  for  protection  all  imply  that  tariff  laws 
should  be  scientifically  adapted  to  secure  the  real  national 


..  o 


360  OUTLINES   OF  ECONOMICS 

purposes  of  protection.  The  impossibility  of  getting  a  "  scien- 
tific tariff "  under  the  political  conditions  that  protection 
creates  is  possibly  one  of  the  strongest  arguments  against  pro- 
tection. 

7.  Finally,  it  is  alleged  that  protection  fosters  monopoly. 
This  contention  forms  the  subject  matter  of  a  particularly 
heated  dispute,  the  exact  truth  of  which  is  difficult  to  determine. 
Certain  modifications  of  the  more  extreme  charge,  however,  are 
hardly  open  to  question.  Protectionists  confessedly  take  it  for 
granted  that  if  foreign  competition  is  shut  off  or  lessened,  home 
producers  will  still  compete.  Nevertheless,  highly  protective 
duties  are  still  levied,  or  until  the  passage  of  the  Underwood 
tariff  were  levied,  upon  the  import  of  commodities  whose  manu- 
facture in  the  United  States  had  fallen  under  the  substantial 
control  of  monopolies.  It  is  furthermore  admitted  that  such 
monopolies  frequently  sell  their  products  at  lower  prices  in 
foreign  countries  than  in  the  United  States ;  while  it  is  impossible 
to  deny  that  —  whether  the  monopoly  was  created  by  protection 
or  not  —  the  abolition  of  the  duties,  by  giving  foreign  producers 
a  chance  to  compete  in  this  country,  would  tend  to  reduce  prices, 
and  thus  give  the  American  public  a  valuable  ally  in  their 
struggle  against  monopoly.  It  is  not  asserted  that  the  tariff 
has  been  "  the  mother  of  the  trusts."  Other  and  more  impor- 
tant forces  are  mainly  responsible  for  the  development  of  the 
trust.  But  protective  tariffs  have  unquestionably  deprived 
the  American  people  of  a  strong  weapon  against  the  trusts. 

Some  General  Considerations.  —  Before  attempting  to  sum 
up  the  preceding  arguments  and  strike  a  practical  working  bal- 
ance, it  is  necessary  to  call  attention  to  certain  general  considera- 
tions which  have  not  figured  in  the  foregoing  "  starched  proces- 
sion "  of  pros  and  cons.  In  the  first  place,  it  is  necessary  to 
remember  that  the  federal  government  must  secure  a  large  rev- 
enue from  tariff  duties,  and  that  in  consequence  the  question 
which  we  are  discussing  is  not  one  of  protection  versus  free  trade, 
but  of  protection  versus  freer  trade.  In  the  second  place, 
the  economic  importance  of  the  whole  controversy  has  unques- 
tionably been  exaggerated.     We  find  a  country  like  England 


PROTECTION  AND  FREE  TRADE         38 1 

prosperous  under  free  trade ;  we  find  countries  like  France  and 
the  United  States  prosperous  under  protection.  It  is  of  real 
but  not  of  vital  importance.  Our  internal  trade  vastly  exceeds 
our  foreign  tr?de  in  every  way.  The  domestic  trade  of  the 
Mississippi  VaD.py  alone  is  far  greater  than  our  entire  foreign 
commerce.  In  the  third  place,  the  American  tariff  is  a  historical 
growth,  and,  bad  as  it  may  be  in  many  respects,  it  has  taken 
deep  root.  During  the  last  century  it  has  bscome  part  of  our 
life,  and  cannot  be  suddenly  eradicated  with  impunity.  If  it 
is  true  that  American  labor  would  be  better  off  without  it,  it 
does  not  follow  that  it  ought  to  be  removed  suddenly  in  the 
interests  of  American  labor.  If  the  industrial  growth  is  ab- 
normal, it  is  none  the  less  true  that  adjustment  to  normal 
conditions  is  a  painful  process  and  should  be  conducted  cau- 
tiously. Displacements  of  labor  and  capital  cause  suffering 
and  loss,  and  it  is  clear  that  any  reform  of  the  tariff  must  be 
conservative  and  careful,  a  movement  toward  freer  trade,  not 
the  sudden  withdrawal  of  protection. 

Conclusions.  —  Most  of  the  arguments  enumerated  above, 
both  for  and  against  protection,  contain  a  measure  of  truth. 
Historically,  protection  was  inevitable  in  the  United  States, 
and,  in  the  early  period  of  the  country's  development,  beneficial. 
During  the  three  great  wars  which  seriously  threatened  the 
stability  of  this  country,  many  new  industries  sprang  up  which, 
upon  the  cessation  of  war  and  the  resumption  of  internal  trade, 
were  seriously  threatened  by  foreign  competition.  Many  of 
these  industries  were  so  suited  to  our  soil  and  our  people  that 
only  a  short  period  of  protection  was  needed  to  make  them  self- 
supporting.  Under  the  circumstances  it  would  have  been  unwise 
to  permit  the  sacrifice  of  the  capital  invested  in  these  industries ; 
and  whether  it  would  have  been  unwise  or  not,  human  nature  is 
such  that  the  desired  protection  was  sure  to  be  granted.  In 
short,  there  is  a  large  measure  of  real  truth  in  the  infant  industry 
argument. 

Circumstances,  however,  have  radically  changed  in  the  last 
few  decades.  Our  quondam  infant  industries  have,  for  the  most 
part,  attained  a  very  vigorous  maturity,  and  in  some  instances 


382  OUTLINES  OF  ECONOMICS 

have  become  belligerent  and  prone  to  monopolistic  bullying, 
our  manufactures  have  become  sufficiently  diversified  to  remove 
all  danger  of  industrial  collapse  in  time  of  war;  and,  above  all, 
we  are  rapidly  entering  the  economic  stage  in  which,  according 
to  the  ablest  exponent  of  protection  that  economic  science  has 
ever  known,  —  Friedrich  List,  —  protection  is  a  hindrance 
rather  than  a  help.  That  is  to  say,  we  are  rapidly  building  up 
an  extensive  export  trade  in  manufactured  articles;  year  by 
year  raw  materials  constitute  a  larger  proportion  of  our  imports 
and  a  smaller  proportion  of  our  exports ;  and  we  have  already 
become  the  greatest  exporting  country  of  the  world.  All  this 
means  that  in  the  near  future  our  manufacturers  themselves 
will  look  with  kindlier  eyes  upon  the  withdrawal  of  the  protec- 
tion they  do  not  need,  which  in  fact  actually  increases  the  cost 
of  some  of  their  raw  materials,  and  incites  foreign  governments 
to  retaliatory  taxation  upon  goods  imported  from  the  United 
States.  Our  growing  export  trade  will  itself  bring  a  wider  ap- 
preciation of  those  fundamental  principles  which  have  led 
economists,  with  but  few  exceptions,  to  condemn  protection  as 
a  permanent  policy  applicable  to  all  stages  of  economic  develop- 
ment. 


QUESTIONS 

1.  Distinguish  what  you  believe  to  be  the  sound  from  what  you  believe 
to  be  the  fallacious  reasons  for  protection,  briefly  stating  your  reasons. 

2.  Why  is  a  home  market  believed  to  be  superior  to  a  foreign  market? 
Does  this  apply  in  all  cases? 

3.  Explain  the  argument  against  dumping.  Is  dumping  more  or  less 
prevalent  than  it  used  to  be? 

4.  Explain  how  one  country  may  influence  the  selection  of  industries 
in  another  country.  Is  this  argument  sound?  What  are  the  limits  of  its 
truth? 

5.  Can  a  protective  tariff  increase  money  wages?  real  wages?  Ex- 
plain. 

6.  State  the  reasons  for,  as  well  as  those  against,  the  proposal  to  use 
tariff  duties  for  the  purpose  of  equalizing  costs  of  production  here  and 
abroad. 

7.  Distinguish  what  you  believe  to  be  the  sound,  from  what  you  believe 
to  be  the  fallacious,  arguments  for  free  trade,  briefly  stating  reasons. 


PROTECTION  AND    FREE   TRADE  383 

8.  What  is  the  difference  between  a  "  tariff  tur  revenue"  and  a  protective 
tariff?     Do  protective  duties  make  good  taxes?     Explain. 

9.  What  effect  has  protection  on  legislation  ?     What  machinery  is  pro- 
posed to  remedy  this  evil  ? 

.  10.  Explain  the  connection,  if  any,  between  high  tariffs  and  monopoly. 

REFERENCES 

Ashley,  Percy,  Modem  Tariff  History,  2d  ed.  (Germany,  United  States, 

and  France). 
Ashley,  W.  J.     The  Tariff  Problem. 
Chomley,  C.  H.     Protection  in  Canada  and  Australasia. 
Dawson,  W.  H.    Protection  in  Germany. 
Fisk,  G.  M.     International  Commercial  Policies. 
Fuchs,  C.  J.     The  Trade  Policy  of  Great  Britain  and  her  Colonies. 
George,  Henry.     Protection  or  Free  Trade. 
Higginson,  J.  L.     Tariffs  at  Work. 
Laughlin,  J.  L.,  and  Willis,  H.  P.     Reciprocity. 
List,  Fried  rich.     National  System  of  Political  Economy. 
Meredith,  H.  O.     Protection  in  France. 
Patten,  S.  N.     The  Economic  Basis  of  Protection. 
Rabbeno,  Ugo.     The  American  Commercial  Policy. 
Smith,  Adam.     The  Wealth  of  Nations,  Book  iv,  Chap.  ii. 
Stanwood,    Edward.    American    Tariff  Controversies   in   the   Nineteenth 

Century. 
Taussig,  F.  W.     Tariff  History  of  the  United  States,  6th  ed. ;  Some  Aspects 

of  the  Tariff  Question ;  (editor)  State  Papers  and  Speeches  on  the  Tariff. 


PART   III 
DISTRIBUTION 

CHAPTER  XIX 
DISTRIBUTION   AS   AN   ECONOMIC   PROBLEM 

It  has  already  been  remarked  that  the  production  and  the  dis- 
tribution of  the  annual  income  of  society  cannot  be  sharply  sepa- 
rated, and  more  or  less  has  already  been  said  about  the  four  parts 
into  which  the  total  social  income  is  usually  divided ;  namely, 
wages,  interest,  rent,  and  profits.  The  greater  part  of  distribu- 
tion might  undoubtedly  be  considered  under  the  general  heading 
"  Production,"  but,  on  the  other  hand,  it  is  frequently  asserted 
that  distribution  is  "  the  true  center  of  all  economic  inquiries,'' 
and  it  would  be  possible  to  treat  nearly  the  whole  of  production 
from  the  standpoint  of  distribution.  The  truth  is  that  these 
old  traditional  divisions  of  our  subject  matter  indicate  different 
points  of  view,  and  on  this  account  it  seems  desirable  to  retain 
them.  When  we  pass  from  production  to  distribution,  we  do 
not  enter  an  entirely  new  field,  but  we  look  at  an  old  field  of 
investigation  from  a  new  point  of  view. 

The  center  of  interest  in  the  practical  applications  of  economic 
principles  has  shifted  from  production  to  distribution.  The  mer- 
cantilistic  writers  of  the  seventeenth  and  eighteenth  centuries 
were  primarily  interested  in  the  most  efficient  ways  of  increasing 
the  sum  total  of  a  nation's  wealth.  Even  Adam  Smith,  as  the 
title  of  his  great  work,  An  Inquiry  into  the  Nature  and  Causes 
of  the  Wealth  of  Nations,  indicates,  had  chiefly  in  mind  the 
same  problem,  although  he  emphasized  the  fact  that  the  real 
well-being  of  a  nation  consists  in  the  well-being  of  the  great 
body  of  its  people.     During  the  past  century  the  production  of 

384 


DISTRIBUTION   AS    AN   ECONOMIC   PROBLEM  385 

wealth  has  increased  beyond  all  precedent,  the  chief  factors 
contributing  to  this  result  being  the  factory  system,  the  ex- 
ploitation of  vast  natural  resources  (made  possible  only  by 
modern  methods  of  transportation),  and  the  free  scope  given  to 
the  initiative  of  the  individual  business  man.  Yet  poverty 
still  exists,  and  its  harsh  features  are  thrown  into  sharper  relief 
by  contrast  with  the  fact  that  the  present  production  of  wealth 
per  capita  is  indisputably  the  highest  that  the  world  has  ever 
known.  Moreover,  while  the  social  discontent  arising  from  in- 
equalities in  the  distribution  of  wealth  is  a  very  old  thing,  it  is 
only  in  modern  times  that  democracy  has  given  it  an  adequate 
opportunity  for  formulated,  organized  expression.  A  large 
share  of  the  economic  problems  which  are  felt  to  press  upon 
society  today  for  solution  relate  directly  or  indirectly  to  the 
distribution  of  wealth. 

It  should  be  noted,  however,  that  we  have  to  discuss  under  the 
name  "  distribution  "  two  different  processes.  The  first  and 
inclusive  meaning  of  the  term  is  the  distribution  of  the  wealth 
or  income  of  society  among  individuals  and  families;  in  other 
words,  the  question  of  individual  fortunes,  poverty,  and  wealth. 
The  second  kind  of  distribution  is  the  apportionment  of  the 
product  to  the  different  factors  of  production.  This  is  not  a 
question  of  wealth  versus  poverty,  but  of  wTages  versus  interest, 
profits,  and  rent.  Of  course,  this  kind  of  distribution  affects 
the  personal  distribution  of  wrealth,  but  it  is  by  no  means  the 
same  question.  To  explain  why  lots  in  New  York  City  com- 
mand high  rents  is  one  thing ;  to  explain  why  a  large  amount  of 
these  rents  goes  to  the  Astor  family  is  another  thing.  In  the 
case  of  wages,  however,  the  two  kinds  of  distribution  amount  to 
about  the  same  thing.  There  is  another  sense  in  which  the 
word  is  not  used  in  this  chapter.  We  do  not  mean  by  distribu- 
tion the  moving  of  goods  from  the  place  where  they  are  produced 
to  the  place  where  they  are  consumed.  When  we  speak  of 
railways  or  merchants  as  "  distributive  agencies,"  we  are  using 
the  term  "  distribution  "  in  a  sense  very  different  from  that  of 
the  technical  economic  term  "  distribution."  Distribution  is  a 
question  of  ownership,  not  a  question  of  the  location  of  goods. 


386  OUTLINES  OF  ECONOMICS 

Distribution  controlled  by  Existing  Institutions.  —  The  statement  that 
distribution  is  a  matter  of  ownership  suggests  at  once  the  relation  of  private 
property  to  distribution.  Individual  wealth  is,  fundamentally,  a  sum  of 
property  rights.  Every  extension  of  property  rights  by  society,  as,  for  ex- 
ample, in  permitting  the  private  ownership  of  the  rights  to  supply  cities  with 
water,  electricity,  or  transportation  facilities,  extends  the  field  of  private 
gain  and  correspondingly  affects  the  distribution  of  wealth.  The  income 
received  by  the  successful  manager  of  a  municipal  waterworks  plant  is  un- 
doubtedly a  very  different  thing  from  the  income  the  same  individual  would 
receive  if  he  were  the  owner  of  a  franchise  permitting  him  to  conduct  the 
business  of  supplying  the  city  with  water  as  a  private  undertaking.  The 
policy  of  leasing,  rather  than  selling,  public  lands,  which  has  been  adopted 
by  some  of  the  newer  American  states,  is  bound  to  have  an  appreciable, 
even  if  not  a  very  important,  effect  upon  the  distribution  of  wealth. 

In  the  institution  of  inheritance  we  have  an  instrument  which  once  in  a 
generation  redistributes  the  property  rights  in  existing  wealth.  It  is  not 
strange  that  those  who  wish  to  limit  or  retard  the  growth  of  large  individual 
fortunes  have  looked  to  the  control  and  especially  to  the  taxation  of  inherit- 
ances as  a  means  to  this  end.  Doubtless  the  prevalence  of  large  landed 
estates  in  England  is  closely  connected  with  the  English  law  of  primogeniture, 
just  as  the  predominance  of  small  holdings  in  France  is  in  part  due  to  the 
French  law  forbidding  the  disinheritance  of  any  of  one's  children. 

Personal  freedom,  as  a  legally  guaranteed  institution,  is  also  of  funda- 
mental importance.  The  factors  determining  the  income  of  the  free  work- 
ingman  are  very  different  from  those  determining  the  portion  of  the  slave. 
It  should  be  remembered,  too,  that  the  actual  processes  by  which  wealth  is 
distributed  are  today  largely  controlled  by  the  institution  of  contract. 
What  rent,  wages,  or  interest  one  gives  or  receives  is  no  longer  fixed  mainly 
by  custom,  as  in  the  Middle  Ages,  but  is  a  matter  of  agreement  between 
individuals.  So  far  as  society  limits  the  right  of  contract,  as  in  the  case  of 
legislation  regulating  the  employment  of  women  and  children,  it  corre- 
spondingly affects  the  distribution  of  wealth. 

These  fundamental  institutions  are  discussed  more  fully  elsewhere  in  this 
treatise.  They  are  mentioned  in  this  connection  in  order  to  emphasize  more 
definitely  the  fact  that  the  distribution  of  wealth  takes  place  under  the  con- 
ditions imposed  by  the  existing  social  order.  Even  the  most  radical  advo- 
cates of  greater  equality  in  the  distribution  of  wealth  do  not  propose  an 
arbitrary  leveling  down  of  fortunes.  They  direct  their  attacks  against  one 
or  more  of  these  fundamental  institutions,  such  as  inheritance,  private  prop- 
erty in  land,  or  private  property  in  production  goods.  Then  there  are  many 
persons  who  are  willing  to  accept  the  conditions  imposed  by  the  existing 
social  order,  as  a  field  for  the  operation  of  competitive  forces  in  wealth  distribu- 
tion, but  who  object  to  monopoly  and  special  privilege.  This  suggests  that 
the  forces  bringing  about  distribution  on  the  basis  of  the  existing  social  order 


DISTRIBUTION   AS   AX   ECONOMIC   PROBLEM  387 

are  in  themselves  amenable  to  social  control.  If  those  who  secure  the  chief 
prizes  in  the  economic  struggle  may  plume  themselves  on  the  fact  that  they 
are  the  victors  in  a  game  that  is  open  to  all,  it  is  none  the  less  true  that 
society  lays  down  the  rules  of  the  game. 

A  large  part  of  the  complex  of  institutions  and  regulations  through  which 
society  controls  distribution  work  smoothly  and  silently,  their  action,  so  far 
as  society  at  large  is  concerned,  being  unconscious.  It  is  only  when  obvious 
conflicts  arise  between  some  of  the  effects  of  this  unconscious  control  on  the 
one  hand  and  present-day  ideals  of  social  welfare  on  the  other  hand,  that  the 
significance  01  any  part  of  this  fundamental  institutional  control  becomes 
generally  felt.  It  is  not  the  least  of  the  merits  of  the  study  of  economics  that 
it  emphasizes  the  fundamental  character  of  that  part  of  the  social  control 
of  wealth  production  and  wealth  distribution  which  lies  below  the  horizon 
of  social  consciousness. 

Money  Incomes.  —  If  each  family  produced  all  that  it  con- 
sumed, as  most  families  still  do  in  part,  there  would  be  no 
problem  of  distribution,  except  whatever  problems  might  arise 
respecting  the  factors  determining  the  amount  produced  by  each 
family.  But  since  most  men  today  are  working  in  more  or  less 
specialized  employments,  and  for  money  incomes,  the  fact  is,  as 
was  suggested  in  a  previous  chapter,  that  distribution  takes 
place  through  a  process  of  price-fixing.  Some  men  (manu- 
facturers, merchants,  farmers)  make  a  money  income  by  selling 
goods  for  more  than  it  costs  them  to  produce  them  or  to  buy 
them  from  others,  while  other  men  (laborers,  salaried  employees, 
professional  men,  capitalists,  landowners)  get  a  money  income 
by  selling  their  services  or  by  selling  the  use  of  their  capital  or 
land.  In  the  first  case,  the  money  income  takes  the  form  of 
profits ;  in  the  second  case,  it  is  wages,  interest,  or  rent,  as  the 
case  may  be. 

A  man's  real  income  consists  of  the  commodities  and  services 
that  satisfy  his  wants ;  and  the  extent  to  which  his  money  in- 
come can  be  transmuted  into  real  income  depends  on  the  prices 
of  these  things.  One  always  has  the  option,  of  course,  of  in- 
vesting part  of  his  money  income  in  production  goods  rather 
than  in  consumption  goods,  thus  giving  up  part  of  his  present 
real  income  for  a  larger  future  income.  However,  since  different 
men  have  to  pay  about  the  same  prices  for  the  same  kinds  of 
goods,  a  discussion  of  the  factors  determining  money  incomes 


388  OUTLINES  OF  ECONOMICS 

will  be,  ipso  facto,  a  discussion  of  the  factors  determining  real 
incomes,  except  as  it  is  found  that  certain  kinds  of  incomes  are 
changed  more  readily  to  meet  the  conditions  imposed  by  changes 
in  prices  than  are  other  kinds  of  income. 

It  is  obvious  that  one  person  may  be  the  recipient  of  more  than 
one  kind  of  income.  The  American  farmer  who  owns  the  land,, 
buildings,  farm  machinery,  and  live  stock  that  make  up  his  pro- 
ductive equipment,  and  who  does  part  of  his  own  work,  is  at  the 
same  time  entrepreneur,  landlord,  capitalist,  and  laborer;  and 
his  income  is  made  up  of  different  proportions  of  profits,  rent, 
interest,  and  wages.  The  net  income  of  a  tenant  farmer, 
utilizing  only  borrowed  capital,  and  employing  only  hired  labor, 
would,  on  the  other  hand,  consist  entirely  of  profits.  The 
economic  analysis  that  seeks  to  determine  the  rules  governing 
the  apportionment  of  the  annual  dividend  under  the  categories 
of  profits,  wages,  rent,  and  interest,  bears  only  indirectly  upon 
the  question  of  the  personal  distribution  of  wealth.  The  in- 
come that  any  individual  receives  depends  primarily  upon  his 
efficiency  and  success  as  a  wage  earner  or  as  an  entrepreneur,  or 
upon  the  amount  and  the  income-yielding  capacity  of  the  capital 
and  land  which  he  owns.  His  ownership  of  capital  and  land 
may  have  come  about  through  the  thrifty  husbanding  of  por- 
tions of  his  income  in  previous  years,  or  it  may  have  come  about 
through  gifts  or  inheritance. 

The  Law  of  Diminishing  Productivity.  —  To  explain  the 
prices  paid  for  personal  services  is  to  explain  wages ;  to  explain 
the  prices  paid  for  the  use  of  land  and  capital  is  to  explain  rent 
and  interest.  Certain  special  and  distinguishing  characteristics 
enter  into  the  determination  of  each  of  these  three  classes  of 
prices.  The  conditions  governing  the  supply  of  labor  are,  for 
example,  very  different  from  the  conditions  governing  the  supply 
of  land.  Yet  there  are  some  fundamental  facts  that  are  common 
to  all  three  classes  of  prices.  The  most  important  of  these  com- 
mon factors  is  the  law  of  diminishing  productivity. 

Assume  as  an  illustration  that  a  certain  farm  is  cultivated  by  a 
farmer  who  uses  only  his  own  labor,  together  with  a  small  amount 
of  capital  in  the  form  of  draft  animals  and  agricultural  imple- 


DISTRIBUTION  AS  AN  ECONOMIC   PROBLEM         389 

merits.  Let  us  assume  further  that  his  land  is  devoted  ex- 
clusively to  the  growing  of  one  crop,  —  corn,  for  instance.  His 
money  income  will  depend  on  the  amount  of  corn  he  can  pro- 
duce and  the  prices  he  can  get  for  it.  At  given  prices  he  can 
increase  his  income  only  by  increasing  his  product. 

But  his  product  may  be  increased  by  the  use  of  any  one  of  a 
number  of  different  methods.  In  the  first  place,  he  can  hire 
a  farm  laborer  to  assist  him.  The  two  men,  working  together, 
will  undoubtedly  be  able  to  get  a  larger  product  from  the  farm 
than  one  man  could.  In  some  cases  they  may  be  able  to  get 
double,  or  even,  through  the  advantages  of  cooperation,  more 
than  double,  what  the  farmer  could  produce  working  alone. 
More  often,  perhaps,  the  employment  of  the  second  man  will 
not  double  the  total  product.  However  that  may  be,  it  is 
absolutely  certain  that  if  the  farmer  employs  a  third,  a  fourth, 
or  even  more  men,  he  will  sooner  or  later  reach  a  point  where 
it  will  be  found  that  the  employment  of  the  last  man  has  not 
increased  the  product  as  much  as  it  was  increased  by  the  last 
previous  laborer.  That  is,  the  addition  of  the  third  man  may 
not  have  increased  the  product  as  much  as  the  employment  of 
the  second  man  did,  or  the  fourth  man  may  not  have  increased 
the  product  as  much  as  the  third  man  did. 

This  point  is  called  the  point  of  diminishing  productivity,1  for 
after  this  point  is  once  reached  it  will  be  found  that,  save  under 
the  most  exceptional  conditions,  each  successive  additional 
laborer  will  increase  the  aggregate  product  by  an  amount  less 
than  the  last  previous  laborer  added  to  it.  This  is  not  because 
of  any  differences  in  the  laborers,  whom  we  assume  to  be  of 
equal  efficiency.  It  means  simply  that  as  the  productive  possi- 
bilities of  the  farm  with  its  equipment  of  capital  become  more 
fully  exploited  through  more  careful  tillage,  it  requires  in- 
creasingly greater  efforts,  in  the  form  of  still  more  careful  and 
thorough  tillage,  to  increase  the  product  by  a  given  amount. 

1  In  some  economic  writings  what  is  here  called  "diminishing  productivity" 
is  termed  "diminishing  returns."  It  seems  preferable  to  reserve  the  latter  term 
for  its  more  familiar  application  to  the  phenomenon  of  the  increasing  expenses 
incurred  in  enlarging  the  total  agricultural  product  under  the  pressure  of  a  popula- 
tion growing  in  numbers  or  in  wealth. 


39°  OUTLINES  OF  ECONOMICS 

This  is  a  fact  of  such  common  observation  that  it  needs  no  statis- 
tical proof;  although  various  agricultural  experiment  stations 
have  made  records  of  the  effect  of  different  degrees  of  thorough- 
ness of  cultivation  upon  the  yield  of  different  crops. 

The  Marginal  Product  of  Labor.  —  One  might  imagine,  at 
first  thought,  that  after  the  point  of  diminishing  productivity 
had  been  reached,  it  would  not  pay  the  farmer  to  hire  additional 
laborers.  But  the  only  question  that  directly  concerns  the 
farmer  in  this  connection  is  whether  an  additional  laborer  will 
"  earn  his  wages,"  —  that  is,  whether  the  added  product  will 
sell  for  enough  to  cover  the  additional  expense  incurred  for  wages. 
It  will  pay  the  farmer  to  extend  his  employment  of  labor  up  to 
the  point  where  the  addition  of  another  laborer  to  the  working 
force  would  increase  the  product  by  an  amount  too  small  to 
sell  for  enough  to  pay  the  wages  of  the  laborer,  and  where  the 
deduction  of  a  laborer  from  the  working  force  would  decrease 
the  product  by  an  amount  at  least  sufficient  to  pay  the  wages  of 
the  laborer.  If  the  farmer  stops  short  of  this  point,  he  is  not 
making  all  the  possible  profits;  if  he  goes  beyond  it,  he  is 
cutting  down  his  profits  by  employing  labor  which  does  not 
"  earn  its  wage."  The  last  laborer  employed  (not  necessarily 
any  particular  laborer,  nor  the  last  in  point  of  time,  but  merely 
any  one  laborer  of  the  total  number  employed)  is  the  marginal 
laborer,  and  the  increase  in  the  total  product  attributable  to  the 
marginal  laborer  (the  part  which  would  be  lost  if  one  less  laborer 
were  employed)  is  the  marginal  product  of  labor.  If  the  farmer 
has  estimated  product  and  prices  accurately,  it  will  be  found,  of 
course,  that  the  money  value  of  the  marginal  product  of  labor 
will  be  approximately  equal  to  the  wages  of  the  marginal  laborer. 
Or,  since  the  laborers  are  supposed  to  be  of  equal  efficiency,  and 
hence  to  receive  uniform  wages,  the  statement  may  be  put  in  the 
broader  and  more  significant  form  that  wages  and  the  marginal 
product  of  labor  will  tend  to  equal  each  other. 

The  diagrams  illustrate  the  principle  of  the  diminishing  productivity  of 
labor,  developed  in  the  foregoing  analysis.  In  Figure  i  the  rectangle  OM 
represents  the  amount  of  corn  that  the  farmer  could  raise  on  his  land  if  work- 
ing alone,  with  his  given  equipment  of  capital.    The  rectangle  A  N  represents 


DISTRIBUTION  AS   AN   ECONOMIC    PROBLEM 


391 


the  increase  in  the  product  effected  by  the  addition  of  another  worker.     Simi- 
larly. BP,  CQ,  DR,  and  ES  represent  respectively  the  additions  to  the  product 


N 

P 

M 

Q 

w 

R 

c 
Fig. 


resulting  from  the  employment  of  a  third,  fourth,  fifth,  and  sixth  laborer. 
If  DR  bushels  of  corn  — ■  the  increment  in  the  product  attributable  to  the  fifth 
laborer  —  sells  for  about  enough  to  pay  the  wages  of  one  laborer,  the  farmer 
will  refuse  to  employ  the  sixth  laborer,  while  the  employment  of  the  fifth 
would  be  a  matter  of  indifference.  If  the  fifth  laborer  were  employed,  the 
proceeds  of  the  sale  of 
that  part  of  the  total 
product  represented  by 
the  rectangle  OERH 
would  be  used  up  in  the 
payment  of  wages  (in- 
cluding payment  for  the 
farmer's  own  work  as  a 
laborer),  while  the  part 
of  the  product  repre- 
sented by  the  small  rec- 
tangles above  the  line 
HW  would  be  left  to 
recompense  the  farmer 
for  the  use  of  his  land, 
for  the  interest  on  and  wear  and  tear  of  his  capital.  If  any  surplus  is  left 
after  these  demands  are  satisfied,  it  would,  of  course,  constitute  the  farmer's 
profits.  If  the  conditions  were  as  assumed,  the  fifth  laborer  would  be  the 
marginal  laborer,  and  the  product  represented  by  the  rectangle  DR  would 
be  the  marginal  product  of  labor. 

If  we  were  dealing  with  a  very  large  undertaking,  in  which  many  laborers 
are  employed,  the  successive  rectangles  representing  the  increments  in  the 


Fig.  2 


392  OUTLINES  OF  ECONOMICS 

product  attributed  to  the  hypothetical  addition  of  successive  laborers  could 
be  conceived  as  indefinitely  narrow,  so  that  the  graphic  representation  would 
take  the  form  represented  in  Figure  2,  where  the  line  AM  is  located  at  the 
point  of  diminishing  productivity,  and  where  the  line  BN  represents  the  mar- 
ginal product  of  labor.  In  this  case  the  rectangle  OBIIN  represents  the  part 
of  the  total  product  which  will  just  suffice  to  pay  the  wages  of  all  the  la- 
borers employed. 

The  Marginal  Products  of  Capital  and  Land.  —  Thus  far 
we  have  supposed  that  the  farmer  is  content  to  get  along  with 
his  original  amount  of  land  and  capital,  and  to  increase  his 
product  by  means  of  an  increased  use  of  labor.  Other  possibili- 
ties are,  of  course,  open  to  him.  It  might  happen  that  he  would 
be  content  to  do  without  additional  laborers,  using  instead  an 
increased  equipment  of  capital.  By  purchasing  more  draft 
animals,  more  labor-saving  machinery,  improved  fertilizers,  or 
possibly  by  installing  drains  or  irrigation  ditches,  as  the  case  may 
be,  he  may  be  able  to  raise  considerably  more  corn  than  he  could 
without  such  investments.  But  here,  again,  he  will  find  the 
possibility  of  increasing  his  product  subject  to  the  same  limita- 
tions that  would  have  prevailed  had  he  increased  his  labor  force. 
With  a  team  of  horses  he  will  be  able  to  accomplish  more  than 
he  could  with  one  horse ;  two  teams  of  horses  may  still  further 
increase  the  total  product  of  the  farm ;  a  third  would  probably 
be  of  very  little  advantage,  and  a  fourth  team  still  less  useful. 
So  with  investments  of  capital  in  other  forms:  the  law  of 
diminishing  productivity  is  a  remorseless  physical  fact  which 
the  farmer  has  to  reckon  with. 

The  concrete  form  in  which  the  problem  presents  itself  to 
him  is  this :  Will  a  further  investment  of  money  in  a  specific  kind 
of  capital  goods  pay  me?  Here  the  farmer  has  to  make  on 
the  one  hand  the  best  estimate  he  can  of  the  amount  which  the 
proposed  capital  goods  will  add  to  his  annual  product,  and  of 
the  probable  selling  value  of  the  increased  product.  On  the 
other  hand,  he  has  to  count  his  increased  annual  expenses. 
These  will  include  (1)  the  original  cost  of  the  additional  equip- 
ment, divided  into  annual  costs  according  to  its  probable  dur- 
ability (each  year's  costs  being  properly  only  the  wear  and  tear, 


DISTRIBUTION  AS   AN   ECONOMIC   PROBLEM  393 

or  "  depreciation  "  attributable  to  that  year's  use) ;  (2)  the 
maintenance  or  upkeep  (including  such  things  as  ordinary 
repairs  on  machinery  and  the  cost  of  feeding  horses),  and  (3) 
the  interest  on  the  investment  (what  the  farmer  has  to  pay  if  he 
borrows  the  necessary  funds  from  some  one  else,  or  what  he 
might  have  lent  his  money  for  to  some  one  else  if  he  uses  his 
own  funds).  Guided  by  these  estimates,  the  farmer  will 
naturally  increase  his  equipment  of  capital  goods  so  far  as  the 
returns  from  the  added  product  would  more  than  suffice  to 
cover  his  increased  costs.  Beyond  this  point  he  could  not 
wisely  go.  The  last  increment  of  capital  —  which  just  suffices 
to  pay  for  itself  —  is  the  marginal  increment  of  capital,  and  the 
added  product  attributable  to  it  is  the  marginal  product  of  capital. 

The  diagrams  portraying  the  operation  of  the  law  of  the  diminishing  pro- 
ductivity of  labor  will  serve  as  well  to  illustrate  the  diminishing  productivity 
of  capital.  Assuming  that  the  amount  of  land  and  the  amount  of  labor  to 
be  utilized  are  definite  in  quantity,  the  successive  rectangles  in  Figure  1  rep- 
resent the  increase  in  the  gross  product  attributable  to  each  of  successive 
increments  of  capital.  Figure  2  represents  the  same  conditions,  except  that 
each  increment  of  capital  is  assumed  to  be  indefinitely  small. 

If  (in  Figure  2)  BN  represents  the  marginal  product  of  capital,  the  whole 
return  imputed  to  capital  is,  of  course,  represented  by  the  rectangle  OBNII. 
The  area  above  the  line  HN  represents  the  part  of  the  product  which  is  avail- 
able for  rent  and  wages,  the  farmer's  profits  being  derived  from  any  surplus 
that  is  left  after  these  demands  are  satisfied. 

There  is  one  difficulty  in  the  foregoing  analysis,  however,  that  may  have 
been  noted  by  the  reader.  What  is  meant  by  an  "increment  of  capital"? 
In  the  case  of  labor  the  "increment  of  labor"  can  be  interpreted  as  the  labor 
(if  one  man  (  for  any  definite  period  of  time  that  may  be  chosen),  the  one  man 
being  assumed  (for  the  purpose  of  simplicity  in  the  analysis)  to  be  of  equal 
efficiency  with  all  others  constituting  the  labor  supply.  It  is  just  as  prac- 
ticable, of  course,  to  assume  that  one  horse  is,  for  the  farmer's  purposes,  just 
as  efficient  as  another  horse,  that  only  one  kind  of  plow  is  available,  and  that 
one  bushel  of  fertilizer  is  exactly  like  any  other  bushel  of  fertilizer;  but  this 
does  not  help  us  out  of  our  difficulty.  For  how  can  we  blend  horses,  plows, 
and  fertilizers  into  one  concept,  and  divide  them  into  "increments  of  capital "  ? 
One  way  of  getting  around  the  difficulty  is  to  think  of  the  capital  which  the 
farmer  combines  with  his  labor  and  his  land  in  terms  of  its  money  value.  In 
this  sense  an  increment  of  capital  might  be  a  dollar's  worth  of  capital,  or  ten 
dollars'  worth  of  capital,  without  reference  to  the  different  kinds  of  concrete 
production  goods  really  composing  it.     This  device  is  useful  for  some  pur- 


394  OUTLINES  OF  ECONOMICS 

poses,  but  it  obscures  the  fundamental  fact  that  capital  gets  its  value  from  its 
ability  to  secure  an  income  for  its  owner.  The  purpose  of  this  analysis  of 
diminishing  productivity  is  to  open  the  way  for  a  discussion  of  the  prices  paid 
for  the  services  of  land,  labor,  and  capital.  To  use  the  term  "capital "  in  the 
sense  of  capital  value  at  this  stage  in  the  discussion  would  only  lead  us  into 
circular  argument.  This  point  cannot  be  further  elaborated  here,  but  should 
be  kept  in  mind  by  the  reader  in  connection  with  the  discussion  of  interest  in  a 
subsequent  chapter.  As  a  matter  of  fact  Die  law  of  diminishing  productivity 
holds  for  each  specific  kitid  of  capital  the  farmer  uses.  For  example,  imagine 
that  the  farmer  is  limited  to  the  use  of  a  fixed  amount  of  all  forms  of  capi- 
tal except  one,  —  horses,  for  instance.  Then  the  successive  rectangles  in 
Figure  i  would  represent  very  well  the  increments  of  product  gained  by  the 
use  of  additional  horses,  while  if  the  product  added  by  the  use  of  a  fifth 
horse  is  just  about  enough  to  pay  for  the  increased  expense,  the  rectangle  DR 
would  represent  the  marginal  product.  The  illustration  can,  by  a  similar 
process,  be  made  to  apply  to  any  other  kind  of  capital.  The  farmer  will 
normally  make  use  of  each  specific  kind  of  capital  up  to  the  marginal  point. 
The  same  is  true  for  each  specific  kind  of  labor  or  each  specific  use  of  labor. 
The  use  of  the  tripartite  classification  of  the  factors  in  production  in 
explaining  the  principle  of  diminishing  productivity  is  merely  a  matter  of 
convenience. 

A  third  way  of  increasing  his  product  is  also  open  to  the  farmer. 
He  may  think  it  wiser  to  get  along  with  his  original  equipment  of 
capital  and  his  own  labor,  and  to  increase  his  product  by  utilizing 
more  land.  The  adoption  of  this  procedure  would  mean  a  less 
intensive  cultivation  per  acre  of  land.  The  use  of  labor  and 
capital  would  have  to  be  distributed  more  thinly  over  the  larger 
acreage.  This  would  result  in  a  smaller  product  per  acre,  but 
the  procedure  would  be  warranted  if  the  increase  in  the  annual 
product  should  sell  for  more  than  the  annual  cost  of  the  addi- 
tional acreage.  By  the  annual  cost  of  additional  land  we  mean 
the  rent  which  the  farmer  has  to  pay  for  the  land  if  he  leases 
it,  or  the  interest  on  the  amount  of  the  purchase  price,  if  he 
buys  it.  It  is  obvious,  however,  that  the  combination  of  more 
and  more  land  with  a  fixed  amount  of  labor  and  capital  will 
result  in  a  smaller  and  smaller  return  per  acre  of  land,  and  that  a 
point  will  soon  be  reached  beyond  which  it  will  not  pay  the 
farmer  to  go.  In  other  words,  the  law  of  diminishing  produc- 
tivity rules  when  land  is  considered  as  the  variable  factor,  just 
as  it  does  when  labor  or  capital  is  considered  as  the  variable. 


DISTRIBUTION   AS   AX    ECONOMIC   PROBLEM  395 

The  diagrams  already  used  may  be  adapted  to  the  illustration  of  the  present 
hypothesis  by  assuming  that  equal  areas,  if  successively  combined  with  a 
given  amount  of  labor  and  capital,  would  yield  increments  of  product  as 
represented  by  the  successive  rectangles  in  Figure  1,  or  by  the  curve  in  Fig- 
ure 2.  It  is  assumed  for  the  sake  of  simplicity  in  the  illustration  that  the  dif- 
ferent acres  of  land  available  for  the  farmer's  use  are  of  equal  fertility. 

The  Actual  Operation  of  Diminishing  Productivity.  —  It  has 
been  assumed  thus  far  that  the  farmer  of  our  illustration  has  to 
be  content  with  a  fixed  quantity  of  two  of  the  three  factors  in 
production,  but  that  he  is  at  liberty  to  increase  his  use  of  the 
third  factor  up  to  the  point  where  maximum  profits  will  be 
gained  for  himself.  Assuming  in  turn  that  each  of  the  three 
factors  in  production  was  the  variable  one,  we  found  that  in 
each  case  the  law  was  the  same  —  the  most  advantageous  ad- 
justment was  reached  when  the  product  added  by  the  last  in- 
crement of  the  variable  factor  would  sell  for  just  enough 1 
to  cover  the  increased  expense. 

In  one  way,  however,  this  assumption  does  not  correspond 
with  the  facts.  The  farmer  is  at  liberty  to  increase  his  product 
by  increasing  his  utilization,  not  only  of  any  one,  but  of  any 
two,  or  all  of  the  three,  factors  of  production.  He  may,  for 
example,  purchase  more  draft  animals  and  more  machinery, 
employ  more  labor,  and  at  the  same  time  acquire  more  land.  To 
a  certain  extent  the  use  of  one  factor  may  lessen  the  use  of 
another  (as  in  the  case  of  labor-saving  machinery  and  labor). 
More  often,  however,  the  reverse  is  true.  The  acquisition  of 
machinery  may  necessitate  the  use  of  more  horses,  while  the 
acquisition  of  more  land  will  often  make  profitable  the  use  of 
more  labor  as  well  as  more  capital  —  a  fact  which  is  itself  im- 
plied in  the  law  of  diminishing  productivity.  Although  the 
employment  of  labor,  capital,  and  land  can  thus  be  increased 
simultaneously,  the  significance  of  the  law  of  diminishing  pro- 
ductivity is  in  no  wise  diminished.  The  farmer,  in  deciding 
upon  the  purchase  of  a  particular  kind  of  capital  good,  has  to 

1  Whether  this  last  unit,  which  just  pays  for  itself,  will  be  added,  is  of  course 
a.  matter  of  indifference.  The  margin  is  consequently  sometimes  called  the  "margin 
of  indifference." 


396  OUTLINES  OF   ECONOMICS 

take  into  account  his  present  and,  to  some  extent,  even  his  prob- 
able future  supply  of  other  kinds  of  capital  goods,  as  well  as  of 
land  and  labor,  before  he  can  form  a  judgment  as  to  the  amount 
which  the  use  of  the  particular  capital  good  will  add  to  his  annual 
product.  Moreover,  he  has  to  choose  between  additional 
investments  in  labor  as  against  additional  investments  in  land, 
or  additional  investments  in  different  kinds  of  capital.  But 
his  effort  to  get  maximum  profits  will  lead  him  to  make  those 
investments  which  promise  to  result  in  the  greatest  additions 
to  his  product.  The  result  of  this  will  be,  normally,  that  each 
factor  in  production  will  be  utilized  up  to  the  marginal  point  — 
the  point  where  further  utilization  would  add  a  product  so 
small  as  to  sell  for  less  than  the  increased  expenses. 

It  is  not  only  in  agriculture  that  the  law  of  diminishing  produc- 
tivity is  the  fundamental  thing  in  determining  the  proportions  in 
which  the  factors  of  production  are  combined.  Every  manufac- 
turer has  the  option  of  using  either  relatively  more  machinery 
and  relatively  less  labor,  or  relatively  less  machinery  and  rela- 
tively more  labor  in  order  to  produce  a  certain  quantity  of 
goods.  He  may  have  to  decide,  also,  between  building  a  six- 
story  factory  covering  an  acre  of  ground,  and  a  one-story  fac- 
tory covering  six  acres  of  ground  —  a  problem  which  is  paralleled 
by  the  farmer's  problem  of  deciding  between  the  cultivation  of  a 
relatively  large  acreage  and  the  more  intensive  cultivation  of  a 
smaller  acreage.  The  entrepreneur  in  every  kind  of  undertaking 
has  to  decide  as  to  the  advisability  of  a  particular  investment  in 
land,  capital,  or  labor,  with  reference  to  the  fundamental  ques- 
tion, "  Will  it  pay?  "  And  the  profitableness  of  any  such  in- 
vestment is  always  a  matter  of  the  cost  of  the  unit  of  land, 
labor,  or  capital,  as  compared  with  the  selling  value  of  the 
quantity  which  it  will  add  to  the  entrepreneur's  total  product. 

In  order  to  achieve  maximum  profits,  each  entrepreneur  will  en- 
deavor, so  far  as  is  practicable,  to  apportion  his  use  of  land,  labor, 
and  capital  so  that  the  value  of  the  increment  of  product  attributable 
to  the  marginal  unit  of  each  class  of  productive  agents  will  about 
equal  its  expense. 

The  significance  of  the  law  of  diminishing  productivity  in  rela- 


DISTRIBUTION  AS   AN  ECONOMIC   PROBLEM  397 

tion  to  the  distribution  of  wealth  now  becomes  apparent.  If  a 
given  class  of  laborers  in  a  given  employment  receive  like  wages, 
their  wages  (being  the  same  as  the  wages  of  the  marginal  laborer) 
will  tend  to  equal  the  marginal  product  of  labor.  The  expense 
incurred  by  the  entrepreneur  for  any  unit  of  a  certain  kind  of 
capital  goods  will  tend  to  equal  the  value  of  the  marginal  product 
of  that  particular  kind  of  capital  goods.  The  rent  which  the 
farmer  will  pay  for  any  acre  of  a  quantity  of  land  of  uniform 
quality  will  tend  to  equal  the.  value  of  the  marginal  product  of 
land  of  that  quality.  But  so  far  as  competition  works  freely, 
different  entrepreneurs  in  the  same  market  will  have  to  pay 
the  same  wages  for  the  same  kind  of  labor,  the  same  price  for 
the  same  kind  of  capital  goods,  and  the  same  rent  for  the  same 
kind  of  land ;  and  they  will  get  the  same  prices  for  the  same  kinds 
of  products.  Moreover  any  one  unit  of  the  aggregate  amount 
of  a  productive  agent  of  any  one  kind  employed  at  any  one  time 
may  be  deemed  to  be  the  marginal  unit.  So  it  is  possible  to 
state  in  more  general  terms  that  the  money  remuneration  of 
each  specific  unit  of  the  agents  of  production  in  production 
tends  to  equal  the  selling  value  of  the  amount  of  product  depend- 
ent upon  the  use  of  that  unit. 

It  is  not  necessary  for  the  validity  of  this  specific  productivity 
theory  of  distribution,  as  it  is  called,  that  in  any  particular 
undertaking  at  any  given  time  the  proportions  in  which  the 
factors  of  production  are  actually  combined  should  be  adjusted 
with  the  nicety  which  the  theory  seems  to  imply.  The  amount 
of  land  which  the  farmer  holds  at  any  one  time  is  apt  to  be  fixed 
by  his  estimate  of  his  future  rather  than  of  his  present  produc- 
tion, while  custom,  pride  of  ownership,  and  the  chance  of  gain 
through  an  increase  in  land  values  (which  is  not  to  be  confused 
with  the  motives  guiding  his  activity  as  a  producer)  have  their 
influence.  Moreover,  the  size  of  the  government  homesteads 
into  which  a  large  part  of  the  public  domain  was  divided  has 
had  an  important  effect  on  the  size  of  the  farmer's  holding  in  a 
large  section  of  the  United  States.  The  average  American 
farmer  undoubtedly  holds  more  land  than  he  would  if  he  were 
looking  for  maximum  present  profits.     The  practical  problem 


398  OUTLINES   OF    ECONuivxxCS 

for  him  is  apt  to  be  how  intensively  he  shall  cultivate  it :  how 
much  labor  and  capital  he  shall  combine  with  it.  That  is,  he 
is  apt  to  use  relatively  more  land  and  relatively  less  labor  and 
capital  than  he  would  use  if  every  additional  acre  of  land  used 
meant  an  additional  expense  for  land.  This  conclusion  is  not 
altered  by  the  fact  that  his  land  is  probably  not  of  uniform 
quality,  and  that  some  of  it  may  not  repay  cultivation  under 
present  conditions.  In  a  similar  way  the  manufacturer  builds 
his  factory  for  the  future,  and  may  even  equip  it  with  a  larger 
complement  of  some  kinds  of  machines  (such  as  boilers  and 
engines)  than  present  requirements  justify.  On  the  other 
hand,  a  sudden  and  probably  temporary  increase  in  demand 
for  a  product  will  be  met  by  the  manufacturers  by  the  employ- 
ment of  more  labor  (even  at  the  high  rate  paid  for  overtime 
or  night  work)  rather  than  by  the  installation  of  more  labor- 
saving  machinery,  even  though  the  latter  might,  in  the  long  run, 
be  more  economical.  In  general,  when  considerations  which 
take  into  account  a  period  of  years  dominate,  land  and  the  more 
permanent  forms  of  capital  goods  will  be  used  more  freely,  labor 
and  the  less  permanent  forms  of  capital  goods  less  freely.  When 
short-time  considerations  are  dominant,  the  reverse  will  be 
true. 

These  limitations  do  not  invalidate  the  law  of  the  equality  of 
the  remuneration  of  the  agents  in  production  and  the  prices  of 
their  specific  products  any  more  than  the  fact  that  a  feather 
does  not  fall  through  the  atmosphere  as  rapidly  as  a  stone  invali- 
dates the  law  of  gravitation.  This  law,  like  other  economic 
laws,  is  the  statement  of  a  fundamental  tendency,  which,  in 
this  case,  is  bound  up  with  the  universal  desire  of  entrepreneurs 
to  get  for  themselves  the  largest  possible  profits. 

Marginal  Productivity  and  the  Prices  of  Production  Goods.  — 
The  reader  who  has  firmly  grasped  the  concept  of  marginal 
utility  will  find  that  a  recognition  of  some  similarities  in  the 
roles  which  marginal  utility  and  marginal  productivity  play  in 
the  price  process  will  help  him  to  grasp  the  significance  of  the 
latter  concept.  The  prices  paid  for  specific  units  of  consumption 
goods  depend  upon  their  relative  capacity  to  yield  an  "  in- 


DISTRIBUTION  AS   AN   ECONOMIC   PROBLEM  399 

come  of  satisfactions  "  ;  the  prices  that  will  be  paid  for  produc- 
tion goods  depend  upon  their  capacity  to  yield  a  money  income 
to  the  entrepreneur.  In  the  one  case  the  law  of  diminishing 
utility  is  dominant ;  in  the  other  case,  the  law  of  diminishing 
productivity.  Just  as  we  cannot  speak  of  the  utility  of  a  com- 
modity in  general,  but  only  of  the  utility  of  particular  concrete 
units  of  a  commodity,  so  we  cannot  speak  of  the  productivity 
of  land,  labor,  or  capital  in  general,  but  only  of  the  productivity 
of  particular  concrete  units  of  land,  labor,  and  capital.  The 
consumer  is  getting  the  maximum  of  satisfaction  of  his  wants 
when  the  final  dollar  spent  for  one  commodity  satisfies  just  as 
intense  wants  as  the  final  dollar  spent  for  any  other  commodity, 
and  he  apportions  his  expenditures  accordingly.  The  entre- 
preneur is  not  making  maximum  gains  if  his  final  expenditure 
for  any  one  kind  of  productive  agent  adds  more  to  his  product 
than  his  final  expenditure  (of  equal  amount)  for  any  other 
productive  agent,  and  he  tends  to  apportion  his  employment 
of  land  and  of  different  classes  of  labor  and  capital  accordingly. 
But  it  must  not  be  supposed  that  the  statement  that  the  prices 
paid  for  land,  labor,  and  capital  tend  to  equal  the  value  of  their 
marginal  products  is  a  complete  explanation  of  the  valuation 
of  the  services  of  the  factors  in  production  any  more  than  the 
principle  of  marginal  utility  is  a  complete  explanation  of  the 
valuation  of  consumption  goods.  In  fact,  from  one  point  of 
view,  marginal  productivity  itself  depends  upon  the  prices  which 
the  entrepreneur  has  to  pay  for  the  services  of  the  factors  in 
production.  The  prices  of  productive  services  are  like  the  prices 
of  vendible  commodities  in  that  each  buyer  (entrepreneur) 
and  each  seller  (laborer,  capitalist,  landlord)  has  to  buy  and  sell 
at  prices  which,  being  established  by  the  aggregate  demand  and 
supply  of  the  market,  are  beyond  his  own  control.  Yet  this 
aggregate  demand  and  supply  is  the  net  result  of  the  decisions 
made  by  individual  buyers  and  sellers  with  respect  to  the 
amounts  which  they  will  buy  or  sell  at  one  price  or  another. 

The  demand  for  the  use  of  land,  labor,  and  capital  is  ulti- 
mately a  demand  for  their  products  —  the  goods  that  satisfy 
human  wants.     The  entrepreneur's  task  is  to  anticipate  and 


400  OUTLINES   OF  ECONOMICS 

meet  this  demand  —  a  problem  that  takes  the  concrete  form  *»t 
producing  goods  that  will  sell  for  more  than  the  expense  of 
production.  On  the  one  hand  he  has  to  estimate  the  quantities 
which  he  can  sell  at  certain  prices ;  on  the  other  hand,  he  has  to 
take  account  of  the  quantities  which  various  units  of  land, 
labor,  and  capital  will  contribute  to  his  product,  together  with 
the  prices  (rent,  wages,  cost  of  capital  goods,  and  interest)  that 
he  has  to  pay  for  these  units.  Through  his  mediation  the  de- 
mand of  society  for  want-satisfying  goods  becomes  a  demand 
for  the  services  of  certain  quantities  of  land,  labor,  and  capital, 
combined  in  certain  proportions.  And  the  principle  that  guides 
the  entrepreneur's  transformation  of  the  community's  demand 
for  the  products  of  land,  labor,  and  capital  into  his  own  demand 
for  the  services  of  these  factors  in  production  is  the  principle  of 
marginal  productivity.  The  wages,  rent,  and  interest  that  are 
actually  paid  for  the  services  of  the  factors  in  production  are  the 
resultants  of  the  demand  of  entrepreneurs,  on  the  one  hand, 
and  of  the  supply  of  these  factors  on  the  other  hand.  The 
forces  determining  these  prices  are  focused  at  the  margin. 

The  principle  of  marginal  productivity  is  an  illuminating  way 
of  stating  the  problem  of  the  distribution  of  wealth,  rather  than 
a  solution  of  it.  Just  how  supply  and  demand  operate  in  the 
case  of  each  factor  in  production  is  a  topic  to  be  considered  in 
later  chapters.  Just  as  utility  is  at  the  same  time  the  cause  and 
effect  of  price,  so  marginal  productivity  is  at  the  same  time  the 
cause  and  effect  of  wages,  rent,  and  interest.  From  one  point 
of  view  it  is  seen  that  the  competition  of  producers  makes  it 
necessary  that  specific  units  of  land,  labor,  and  capital  should ! 
get  a  reward  proportionate  to  the  selling  price  of  the  amounts 
which  they  contribute  to  the  social  dividend ;  from  another 
point  of  view  it  is  equally  clear  that  the  necessary  expenditures 
for  land,  labor,  and  capital  are,  in  the  long  run,  potent  factors 
in  determining  the  prices  of  the  things  that  make  up  the  social 
dividend. 

The  Meaning  of  "  Productivity."  —  Furthermore,  we  should 
not  forget  that  the  word  "  productivity  "  as  used  in  economics 
(and  generally  in  current  discussions  of  economic  topics)  has  a 


DISTRIBUTION  AS  AN  ECONOMIC  PROBLEM  401 

distinctly  limited  meaning.  To  digress  for  a  moment  in  order 
to  make  the  point  clearer :  In  the  theory  of  consumption  we 
emphasize  the  fact  that  many  of  the  most  important  human 
wants  are  satisfied  by  "  free  goods,"  which,  simply  because  they 
are  free,  lie  outside  the  proper  field  of  economic  investigation. 
But  the  enjoyment  of  these  free  goods  is  usually  dependent 
upon  the  possession  of  economic  goods.  Air  is  a  free  good,  —  to 
any  one  who  can  demand  the  economic  goods  necessary  to  life. 
The  glorious  scenery  of  our  national  parks  is  a  free  good,  — 
to  any  one  who  can  afford  traveling  expenses  and  hotel  bills. 
In  general,  the  enjoyment  of  many  of  the  finer  pleasures  of 
life,  involved  in  the  common  human  relations  of  an  individual 
to  his  physical  and  social  environment,  are  "  free,"  but  free 
only  to  the  individual  who  can  afford  the  leisure  and  the 
economic  goods  without  which  many  of  these  "  free  "  pleasures 
are  impossible. 

For  present  purposes,  however,  the  important  point  is  that 
there  axe  free  production  goods  as  well  as  free  consumption  goods. 
Nature  furnishes  some  of  these.  The  oceans  and  lakes  furnish 
free  pathways  for  commerce ;  natural  forces  of  all  kinds  are 
freely  utilized  by  men  in  the  work  of  production.  But  we  do 
not  call  these  things  productive,  because  no  part  of  the  annual 
product  is  dependent  on  the  utilization  of  any  particular  unit  of 
them.  In  this  technical  sense  the  wind  is  not  productive,  but 
windmills  are.  In  order  to  utilize  the  ocean  we  have  to  invest 
money  in  vessels  and  docks.  We  have  to  impute  productivity 
to  these  things  because  they  will  not  be  furnished  unless  it  is 
estimated  that  they  will  yield  a  remunerative  income,  and  be- 
cause the  annual  product  will  obviously  be  reduced  if  they  are 
not  furnished.  Much  has  been  written  about  the  "  produc- 
tivity "  of  the  Panama  Canal.  But  we  would  have  to  impute 
productivity  to  the  Strait  of  Gibraltar  if  England  were  able  to 
charge  a  toll  for  its  use! 

Somewhat  analogous  to  these  "  free  productive  goods  "  is 
society's  fund  of  accumulated  knowledge  of  productive  methods, 
—  the  heritage  of  centuries  of  economic  evolution.  This 
accumulated  industrial  experience  is  an  infinitely  more  precious 


402  OUTLINES  OF  ECONOMICS 

possession  than  the  existing  store  of  productive  goods.  Compare 
the  productive  possibilities  of  a  community  of  men  possessing 
this  knowledge,  but  forced  to  begin  work  absolutely  without  a 
ready-made  stock  of  capital  goods,  with  those  of  a  tribe  of 
savages  suddenly  and  miraculously  equipped  with  all  the 
productive  appliances  of  modern  civilization.  Yet  this  vast 
fund  of  productive  knowledge,  so  far  as  it  is  common  property, 
is  not  thought  of  as  "  productive."  The  social  dividend  is 
continually  being  increased  as  a  result  of  the  discovery  of  new 
natural  forces,  or  new  ways  of  harnessing  and  utilizing  natural 
forces.  Secrecy  or  government  patents  make  it  possible  for 
those  who  first  introduce  these  new  methods  of  production  to 
reap  an  income  from  the  temporary  advantage  it  gives  to  them 
as  producers.  For  the  time  being  these  new  methods  themselves 
have  to  be  regarded  as  "  productive,"  although  they  contribute 
much  more  to  the  increase  of  the  social  dividend  after  they  have 
become  matters  of  common  knowledge  and  use,  and  hence  have 
ceased  to  be  called  "  productive."  Disinterested  scientists, 
especially  those  in  the  employment  of  the  government  or  of 
universities,  have  often  given  the  results  of  their  improvements 
in  industrial  methods  freely  to  the  world,  thereby  swelling  the 
social  dividend,  but  not  reaping  for  themselves  the  pecuniary 
reward  which  goes  to  those  who  patent  their  improvements 
and  thereby  render  them  "  productive."  Moreover,  many  of 
the  world's  greatest  advances  in  the  technique  of  production 
have  been  made  possible  only  by  the  patient  researches  of  in- 
vestigators in  the  "  unproductive  "  field  of  pure  science,  working 
solely  for  love  of  the  work,  and  without  hope  of  pecuniary 
reward.1 

We  impute  productivity  only  to  goods  or  services  which  are  the 
objects  of  property  rights  or  of  analogous  rights  of  control,  —  such 
as  a  man's  power  to  dispose  of  his  own  labor.  The  fact  is  that 
just  as  the  benefits  of  free  consumption  goods  are  bound  up  with 
the  possession  of  larger  or  smaller  quantities  of  economic  goods, 
so  the  utilization  of  free  productive  agencies  is  possible  only  in 

1  See  a  note  on  this  point  in  Merz,  History  of  European  Thought  in  the  Nine- 
teenth Century,  Vol.  i,  p.  92,  note.    The  list  there  given  could  be  greatly  extended 


DISTRIBUTION   AS   AN   ECONOMIC   PROBLEM  403 

combination  with  labor,  waiting,  and  scarce  and  appropriable 
natural  objects,  —  and  these  have  to  be  paid  for.  We  harness 
natural  forces  for  the  work  of  production,  but  we  impute  produc- 
tivity only  to  the  harness.  We  continually  learn  better  and 
better  methods  of  doing  our  productive  work,  but  we  impute 
productivity  only  to  the  expenses  involved  in  utilizing  these 
methods,  —  not  to  the  methods  themselves.  Productivity  im- 
plies merely  a  relation  of  dependency  between  the  amount  of  the 
product  and  the  use  of  a  partictdar  unit  of  one  of  the  agents  in 
production. 

It  is  important  that  the  reader  should  see  the  truth  in  the 
statement  that  the  laborer,  the  landlord,  and  the  capitalist  get 
paid  in  proportion  to  their  respective  products.  It  is  equally 
important  that  he  should  see  clearly  that  there  are  definite 
limitations  to  the  meaning  and  significance  of  the  statement. 

The  statement  that  rewards  tend  to  equal  products  has  no  ethical  sig- 
nificance, and  should  not  be  interpreted  as  a  justification  of  the  present  eco- 
nomic order,  —  and  this  for  the  following  reasons  among  others  :  ( 1 )  That  dis- 
tribution ought  to  be  according  to  productivity  is  itself  a  debatable  proposi- 
tion. Some  socialists,  for  example,  maintain  that  distribution  according  to 
needs  is  a  higher  ideal.  (2)  The  ethical  side  of  the  problem  of  distribution 
relates  to  personal  distribution,  while  the  marginal  productivity  doctrine 
relates  to  the  determination  of  the  incomes  going  to  the  different  agents  in 
production.  To  state  that  the  rent  of  an  acre  of  land  tends  to  equal  the  value 
of  its  product  is  not  to  say  that  the  landowner  has  "earned"  his  income 
The  private  receipt  of  rent  depends  upon  such  social  institutions  as  private 
property  and  inheritance,  and  these  have  to  be  judged  from  the  broad 
point  of  view  of  social  welfare.  (3)  The  efficiency  of  the  individual  laborer, 
which  is  one  of  the  things  determining  his  productivity,  often  depends  upon 
the  opportunity  he  has  had  to  "make  the  most  of  himself."  But  opportu- 
nity depends  largely  on  environment,  and  this  in  turn  is  to  a  large  extent 
amenable  to  social  control.  (4)  The  amount  of  the  marginal  product  of  any 
one  factor  in  production  is  itself  a  resultant  of  all  the  forces  affecting  the 
supply  of  all  the  factors  in  production  and  of  all  the  conditions  that  affect 
their  fitness  to  serve  in  the  production  of  the  things  that  consumers  are 
demanding.  (5)  This  theory  is  only  a  statement  of  a  normal  tendency.  It 
does  not,  properly  understood,  conflict  with  the  fact  that  such  things  as 
custom  and  other  forms  of  economic  friction  and  inertia,  the  higgling  of  the 
market,  the  conscious  efforts  of  social  classes  to  better  their  condition, 
imperfections  in  the  monetary  system,  short-sighted  selfishness  on  the  one 
hand,  altruism  on  the  other,  as  well  as  the  conscious  social  control  expressed 


404  OUTLINES   OF   ECONOMICS 

in  labor  legislation,  usury  laws,  and  the  like,  all  have  important  effects  upon 
the  incomes  actually  received  by  those  who  furnish  labor,  capital,  and  land  for 
the  work  of  production.  Actual  wages  may  differ  from  the  normal  wages 
measured  by  marginal  product  just  as  contractual  rent  may  differ  from 
economic  rent.  (6)  We  can  imagine  an  economic  order  very  different  from 
the  present  one  in  which  it  would  still  be  true  that  incomes  would  tend 
to  equal  products.  If,  for  example,  wages  were  arbitrarily  increased  50  per 
cent  by  la  v,  virile  one  result  would  Undoubtedly  be  an  increase  in  unem- 
ployment, it  would  still  be  true  that  wages  would  tend  to  equal  the  marginal 
product  of  labor,  or,  rather,  that  the  marginal  product  of  labor  would  tend  to 
equal  wages.  To  attempt  to  avoid  this  difficulty  by  assuming  that  the 
present  order,  or  a  purely  competitive  order,  is  the  "natural"  order  of  things, 
is  to  beg  the  whole  Question  in  favor  of  the  existing  status. 

Social  Aspects  of  Diminishing  Productivity.  —  Since  the 
entrepreneurs  are  only  the  intermediaries  between  society  viewed 
as  a  body  of  consumers  and  society  viewed  as  a  body  of  pro- 
ducers, we  may,  for  present  purposes,  leave  them  out  of  con- 
sideration, in  order  to  fix  our  attention  upon  some  of  the  more 
general  results  of  the  fact  of  diminishing  productivity. 

If  the  number  of  laborers  within  the  boundaries  of  a  nation  is 
increased  by  immigration,  without  a  corresponding  increase  in 
capital  or  in  the  amount  of  land  available  for  use,  the  result  will 
be  an  increase  in  the  total  amount  of  goods  produced,  which 
means  an  increase  in  the  amount  of  wealth  produced  per  unit 
of  land  and  capital,  but  (on  account  of  the  operation  of  the  law 
of  diminishing  productivity)  a  decreased  amount  per  laborer; 
a  higher  marginal  product  for  land  and  capital,  and  a  lower 
marginal  product  for  labor;  consequently,  higher  rent  and 
higher  interest,  but  lower  wages.  If  the  supply  of  capital  within 
a  country  is  increased,  while  labor  and  land  remain  constant, 
the  result  will  be  higher  wages  and  higher  rents,  but  a  smaller 
remuneration  for  capital.  Similarly,  if  the  available  supply  of 
land  be  increased  (as  by  improvements  in  transportation  facili- 
ties), rent  will  absorb  relatively  less,  and  wages  and  interest 
relatively  more,  of  the  value  of  the  total  product. 

In  a  very  real  sense  the  same  laborer  is  more  productive  in  a 
country  where  land  is  relatively  plentiful  than  in  a  country 
where  land  is  relatively  scarce.    A  laborer  may  gain  no  technical 


DISTRIBUTION  AS  AN  ECONOMIC  PROBLEM  405 

efficiency  by  migration  from  Europe  to  America,  but  the  in- 
crement of  product  attributable  to  his  work  is  apt  to  be  con- 
siderably larger  in  the  United  States  than  it  was  in  Europe. 
Here  he  really  creates  a  larger  product  and  earns  a  larger  wage. 
The  migrations  of  labor  and  capital  from  one  region  to  another, 
or  from  one  country  to  another,  are  guided  by  the  endeavors  of 
capitalists  and  laborers  to  get  the  maximum  remuneration,  — 
which  will  always  be  found  where  the  price  of  the  marginal 
product  of  capital  or  labor  is  a  maximum. 

In  a  prosperous  country  it  is  apt  to  be  the  case  that  the  supply 
of  labor  and  the  supply  of  capital  are  being  increased  simultane- 
ously, though  not  necessarily  with  equal  rapidity,  while  more 
land  is  at  the  same  time  being  made  available  through  improve- 
ments in  transportation.  Save  under  such  exceptional  condi- 
tions of  railway  building  as  prevailed  in  the  United  States 
during  the  forty  years  following  the  Civil  War,  the  available 
supply  of  land  is  apt  to  increase  more  slowly  than  the  other 
factors  in  production  increase.  In  general,  the  law  of  diminish- 
ing productivity  will  necessitate  a  continual  increase  in  the 
proportion  of  the  product  set  aside  for  the  remuneration  of 
each  unit  of  the  most  slowly  increasing  factor  in  production ; 
while,  of  the  other  two  factors,  the  one  that  increases  more 
rapidly  will  receive,  per  unit,  a  relatively  smaller  and  smaller 
proportion  of  the  value  of  the  total  product. 

QUESTIONS 

1.  Do  you  know  of  any  instances  where  the  distribution  of  wealth  has 
been  affected,  directly  or  indirectly,  by  conscious  social  action? 

2.  Prepare  tables  or  diagrams  roughly  illustrating  the  operation  of  the 
law  of  diminishing  productivity  in  some  industry  with  which  you  are  familiar. 

3.  Why  is  the  same  laborer  more  productive  in  America  than  in  Europe? 
Is  this  a  condition  that  will  probably  continue  indefinitely? 

4.  Why  do  lands  in  Belgium  produce  more  per  acre  than  similar  lands  in 
the  United  States? 

5.  Is  the  fact  that  the  average  wheat  crop  per  acre  is  larger  in  Europe 
than  in  the  United  States  an  indication  that  European  agricultural  methods 
are  superior? 

6.  Which  is  the  more  significant :  product  per  acre  or  product  per  man? 

7.  Why  are  twenty-story  office  buildings  not  erected  in  small  cities? 


406  OUTLINES  OF  ECONOMICS 

8.   Can  an  entrepreneur  increase  his  product  indefinitely  by  using  con- 
tinually larger  amounts  of  all  the  agents  in  production? 

o.   What  is  the  relation  of  the  discussion  in  this  chapter  to  the  socialist 
contention  that  labor  produces  all  wealth? 
10.   Discuss  the  following  statement: 

"Each  man,  taking  account  of  his  own  means,  will  push  the  investment 
of  capital  in  his  business  in  each  several  direction  until  what  appears  in  his 
judgment  to  be  the  outer  limit,  or  margin,  of  profitableness  is  reached;  that 
is,  until  there  seems  to  him  no  good  reason  for  thinking  that  the  gains 
resulting  from  any  further  investment  in  that  particular  direction  would 
compensate  him  for  his  outlay.  The  margin  of  profitableness  is  not  to  be 
regarded  as  a  mere  point  on  any  one  fixed  line  of  profitable  investment ;  but 
as  a  boundary  line  of  irregular  shape  cutting  one  after  another  every  possible 
line  of  investment."  Alfred  Marshall,  Principles  of  Economics,  6th  ed., 
P-  356. 

REFERENCES 

Carver,  T.  N.     The  Distribution  of  Wealth,  Chap.  ii. 
Clark,  J.  B.     The  Distribution  of  Wealth,  Chaps,  vii-xiii. 
Commons,  J.  R.     The  Distribution  of  Wealth,  Chap.  iii. 
Davenport,  H.  J.,      Economics  of  Enterprise,  Chaps,  ix,  x,  xxiii,  xxiv. 
Marshall,  Alfred.     Principles  of  Economics,  6th  ed.,  Book  v,  Chap.  viii. 
Book  vi,  Chaps,  i,  ii. 


CHAPTER  XX 
THE   RENT    OF   LAND 

Rent  is  the  price  paid  for  the  services  of  land.  In  common 
usage  the  meaning  of  the  word  is,  however,  much  less  exact. 
That  which  one  pays  for  the  use  of  durable  goods  of  any  kind 
owned  by  another  is  commonly  called  rent.  The  payment  for 
the  use  of  a  house  or  a  business  building  is,  for  example,  counted 
as  rent.  We  shall  see  that  in  this  case  the  so-called  rent  really 
consists  of  two  elements,  —  one  a  ground  rent,  or  rent  proper, 
the  other  capital  rent.  If  this  distinction  seems  fanciful,  it  is 
only  because  we  are  accustomed  to  see  the  two  united  under 
one  ownership.  But  in  most  large  cities  separate  ownership 
is  common.  Sometimes  one  man  owns  the  land  and  leases  it 
for  a  long  term  of  years  to  another  who  erects  buildings  upon 
it,  which,  either  with  or  without  payment,  become  the  property 
of  the  landowner  at  the  expiration  of  the  lease,  unless  it  is 
renewed,  and  if  it  is  renewed,  the  one  who  possesses  the  build- 
ing must  frequently  pay  for  it.  Often,  however,  the  separa- 
tion in  ownership  is  permanent,  the  house  owner  paying  per- 
petually an  annual  sum  for  the  use  of  the  ground.  This  is  the 
case  in  Baltimore,  for  example,  where  ground  rents  are  an 
important  feature  in  the  economic  life  of  the  city.  In  such 
cases  the  two  kinds  of  income  are  very  clearly  distinguished. 

Some  modern  economists  have  extended  the  meaning  of  both 
rent  and  interest,  using  them  as  two  different  ways  of  describ- 
ing one  form  of  income,  rather  than  as  two  distinct  kinds  of  in- 
come. This  usage  is  based  on  the  obvious  fact  that  the  rent 
which  a  landlord  receives  for  an  acre  of  land  may  easily  be  com- 
puted as  a  certain  rate  of  interest  on  the  money  value  of  the  land, 
just  as  the  amount  earned  by  a  machine  may  be  viewed  either 
as  the  rent  of  the  machine  or  as  interest  on  its  money  price, 

407 


408  OUTLINES   OF   ECONOMICS 

But  we  shall  see  later  that  the  income  from  other  production 
goods,  while  governed  in  part  by  the  same  laws  that  control  the 
income  from  land,  is  also  governed  in  part  by  very  different 
laws.  Without  dwelling  further  upon  this  distinction  at  this 
stage  of  our  discussion,  let  us  remember  that  in  the  great  ma- 
jority of  economic  writings  the  term  "  rent  "  means  only  an 
income  derived  from  the  ownership  of  land,  and  that  it  is  used 
only  in  this  sense  in  the  following  discussion. 
,  The  Services  of  Land.  — The  first  thing  to.be  noted  about 
land  is  its  quality.  Differences  of  fertility  are  familiar  to  every 
one,  and  depend  upon  what  have  been  known  as  the  "  original 
and  indestructible  properties  of  the  soil."  An  effort  has  been 
made  by  certain  writers  to  minimize  or  deny  the  significance  of 
this  factor.  It  has  been  said  that  "  soil  "  is  not  indestructible, 
that  it  may  be  exhausted  or  removed  from  land  altogether, 
and  that  it  may  in  turn  be  created  by  means  of  fertilization. 
These  writers  recognize  in  land  no  other  indestructible  property 
than  standing  room.  This  objection  arises  from  the  use  of  the 
word  "  soil  "  in  a  narrow  sense. 

If  by  "  soil  "  we  mean  only  that  thin  top  layer  containing 
some  elements  necessary  to  plant  life,  it  is  true  that  this  may 
be  carted  on  or  off  at  pleasure,  that  it  may  be  wasted  or  replen- 
ished. But,  granting  this,  there  still  remain  many  qualities 
of  land  which  are  indestructible  and  unproducible,  and  which 
so  directly  affect  the  productiveness  of  the  land  that  we  may  not 
inappropriately  call  them  "  properties  of  the  soil."  Such  a 
property  is  the  conformation  of  the  land.  A  steep,  gravelly 
hillside  will  by  no  possible  effort  equal  a  plain  in  fertility.  The 
north  side  of  a  mountain  cannot  be  made  to  produce  the  same 
as  the  south  side.  Climate  is  not,  to  be  sure,  a  "  property  of 
the  soil,"  but  it  is  an  inseparable  appurtenance  of  the  land, 
and  upon  it  the  productiveness  of  the  land  in  large  measure 
depends.  The  ownership  of  a  piece  of  land  carries  with  it  the 
advantage  of  all  the  conditions  which  attach  to  that  land. 
The  expression,  "  original  and  indestructible  properties  of  the 
soil."  is  inadequate  and  misleading;  but  it  covers  more  than 
mere  "  standing  room." 


THE   RENT   OF  LAND  409 

We  will,  therefore,  adopt  another  expression  to  explain  what, 
we  mean  by  quality  in  land ;  namely,  the  irremovable  conditions 
affecting  its  productiveness.  Of  these  its  extent  (standing  room), 
its  conformation,  and  its  climate  are  essentially  original  and  in- 
destructible. Others,  such  as  are  connected  with  the  "  soil  "  in 
the  narrow  sense,  are  not  indestructible  nor  necessarily  original, 
but  they  affect  rent  none  the  less.  Fertility,  even  when  arti- 
ficial, becomes  essentially  a  property  of  the  land.  From  the 
case  where  capital  is  embodied  in  land  and  entirely  assimilated 
to  it  in  character,  we  pass  by  insensible  gradations  to  fences, 
barns,  houses,  etc.,  which  more  and  more  assume  the  character 
of  capital  as  distinguished  from  land.  It  would  be  possible 
to  restrict  the  term  "  land  "  to  strictly  natural  or  "  original  " 
land,  and  apply  the  term  "  capital  "  to  all  products,  including 
the  soils  of  old  land.  This  would  be  a  logical  distinction,  but, 
like  so  many  logical  distinctions,  would  be  confusing.  On  the 
other  hand,  if  we  include  under  land  all  capital  that  has  been 
incorporated  in  it,  we  must  recognize  that  there  is  no  absolute 
line  of  division  between  land  and  capital.  Thus  we  are  again 
reminded  that  distinctions  in  economics,  as  well  as  in  practical 
life,  are  questions  of  convenience,  and  are  good  or  bad  accord- 
ing as  they  are  more  or  less  useful. 

The  second  great  fact  regarding  land  is  location.  On  one  side 
this  is  closely  connected  with  climate.  But  a  more  distinct 
meaning  of  the  word  is  situation  with  respect  to  markets. 
Everybody  knows  that  land  a  hundred  miles  from  market  is, 
other  things  being  equal,  worth  more  than  land  a  thousand  miles 
from  market.  This,  however,  is  a  question  of  accessibility  rather 
than  of  mere  distance.  Land  may  be  far  away  and  yet  easy  to 
reach,  or  near  and  difficult  of  access.  Any  change  in  the  expense 
of  transportation  affects  rents.  The  rents  of  England  have 
been  revolutionized  by  cheap  ocean  transportation,  which  has 
practically  brought  distant  land  very  near  to  her  shores.  To 
this  fact  of  location  we  must  ascribe  almost  wholly  the  enormous 
rents  paid  for  city  lots.  Here,  again,  transportation  facilities 
powerfully  affect  rents. 

One  important  difference  in  the  way  quality  and  location  affect 


410  OUTLINES  OF  ECONOMICS 

rent  must,  however,  be  noted.  The  quality  of  a  piece  of  land 
affects  the  amount  of  its  physical  product;  it  determines  how 
many  bushels  of  wheat  or  how  many  pounds  of  cotton  it  will 
yield  with  a  given  amount  of  cultivation.  The  location  of  land 
does  not,  it  is  true,  affect  the  amount  of  its  physical  product, 
but  it  does  affect  the  price  of  the  product,  since  that  varies  with 
the  expense  of  transporting  the  product  to  market.  The  money 
value  of  a  piece  of  land  to  the  user  depends  upon  the  money 
value  of  its  yield,  which  is,  of  course,  the  number  of  units  of 
products  multiplied  by  the  price  per  unit.  Suppose  a  man 
owns  two  wheat  farms  of  equal  size,  one  in  Dakota  and  one  in 
Illinois.  If  the  farm  in  Dakota  produces  thirty  bushels  of 
wheat  to  the  acre,  and  it  costs  twenty  cents  a  bushel  to  get  it 
to  the  Chicago  market,  where  wheat  is  selling  at  a  dollar  per 
bushel,  while  the  farm  in  Illinois  produces  twenty-five  bushels 
to  the  acre,  and  it  costs  four  cents  a  bushel  to  get  this  to  the 
Chicago  market,  the  farms  are  equally  productive  so  far  as 
the  owner  is  concerned,  for  in  each  case  he  will  get  $24  for  an 
acre's  yield  of  wheat.  If  the  other  conditions  of  production 
are  the  same,  the  farms  are  equally  valuable  to  the  owner. 
From  the  social  point  of  view,  too,  one  of  the  farms  is  as  good 
as  the  other.  For  the  costs  of  transportation,  of  moving  things 
to  where  they  are  wanted,  have  to  be  counted  among  the  legiti- 
mate and  necessary  costs  of  production.  In  short,  we  may  say 
that  the  two  pieces  of  land  are  equally  good  land.  When  we 
speak  of  good  land,  therefore,  in  connection  with  the  subject 
of  rent,  we  mean  land  which  for  all  purposes  taken  together  is 
desirable. 

Rent  under  Assumed  Conditions  of  Uniform  Intensivity  of 
Cultivation.  —  The  first  settlers  in  a  new  country  have  no  need  to 
pay  rent.  They  find  plenty  of  land,  and  even  the  best  of  it  will 
be  a  free  good,  like  air  or  water.  So  long  as  any  man  can  get  land 
of  the  best  quality  free,  there  is  no  reason  why  he  should  pay  rent 
to  any  one  else.  But  this  fortunate  state  of  affairs  will  last  only 
so  long  as  some  of  the  best  lands  remain  unoccupied.  When 
increase  in  the  population  makes  the  utilization  of  inferior  lands 
necessary,  the  owners  of  the  better  lands  will  be  able  to  demand 


THE   RENT  OF  LAND 


411 


and  receive  a  rent  for  the  use  of  their  lands.  This  will  be  made 
clear  by  reference  to  Figure  1,  which  is  constructed  on  the 
assumption  that  there  are  six  grades  of  land,  A,  B,  C,  D,  E, 
and  F,  and  that  for  all  these  lands  the  same  amount  of  cultiva- 
tion per  acre  is  necessary.  The  successive  rectangles  repre- 
sent the  selling  value  of  the  product  that  can  be  raised  on  one 


B 


!■: 


F,G. 


acre  of  each  of  these  different  grades  of  land,  by  the  use  of  a 
fixed  amount  of  labor  and  capital.  The  product  of  an  acre 
of  the  best  land,  A,  will  sell  for  Oamy  dollars.  Until  all  of  this 
best  land  is  occupied,  no  rent  will  be  paid,  and  the  entire  value 
of  the  product  will  be  available  for  the  expense  of  the  capital 
and  the  wages  of  labor  employed  in  its  cultivation.1 

As  soon,  however,  as  it  becomes  necessary  to  cultivate  some  of 
the  B  lands,  the  situation  will  be  altered.  The  owners  of  the  A 
lands  can  now  exact  a  rent  for  their  use,  and  the  tenant  farmer 
has  no  alternative,  except  to  utilize  land  of  the  second  grade, 
on  which  the  fixed  amount  of  labor  and  capital  will  only  produce 
a  product  per  acre  selling  for  abnk  dollars.  The  rent  which 
will  be  paid  per  acre  for  A  lands  will  amount  to  the  difference 
between  the  value  of  the  products  of  the  two  grades  of  land 
(hkmy  in  the  diagram).  For  if  the  landowners  attempt  to  charge 
more  than  this  difference,   tenant  farmers  will   find  it  more 


1  The  profits  which  the  farmer  may  receive  as  entrepreneur  do  not  affect  the 
analysis,  and  may  accordingly  be  neglected. 


412  OUTLINES  OF  ECONOMICS 

advantageous  to  use  the  B  lands;  if  they  charge  less,  the  A 
lands  will  be  the  more  remunerative  to  the  farmer,  and  competi- 
tion among  the  farmers  for  the  leases  of  A  lands  will  force  the 
rent  up.  In  short,  rent  will  normally  be  fixed  at  the  point 
which  will  just  equalize  the  advantages  of  cultivating  the  two  kinds 
of  land. 

As  soon  as  increased  population  and  the  consequent  need  of 
a  larger  food  supply  and  more  raw  materials  have  forced  men  to 
begin  to  cultivate  lands  of  the  C  grade,  the  B  lands  will  command 
a  rent,  while  the  rent  of  the  A  lands  will  be  increased  by  an 
amount  equal  to  the  rent  of  the  B  lands.  And  as  cultivation  is 
pushed  down  to  still  poorer  and  poorer  lands,  the  rents  which 
these  better  lands  command  will  be  still  further  increased. 
Thus,  when  some  lands  of  grade  E  are  in  use,  the  value  of  the 
product  which  can  be  got  from  this  free  land,  by  the  use  of  the 
fixed  amount  of  labor  and  capital,  will  be  dert  dollars  per  acre. 
This  sum  will  just  about  pay  the  cost  of  labor  and  capital,  for  if 
it  amounts  to  less  than  these  expenses  of  production,  the  E  lands 
will  not  be  worth  cultivating ;  if  it  amounts  to  very  much  more, 
it  will  pay  to  cultivate  still  poorer  land.  But  if  dert  dollars 
will  just  pay  wages  and  interest  on  the  E  lands,  the  same 
sum  will  pay  wages  and  interest  on  the  better  lands,  for  we 
have  assumed  that  the  same  amount  of  labor  and  capital 
is  used  on  each  grade  of  land.  The  expense  for  labor  and 
capital  will,  therefore,  be  represented  on  each  rectangle  by 
the  area  below  the  line  gt,  while  the  area  above  this  line  will 
represent  in  each  case  the  rent  per  acre  which  the  landowner 
will  receive. 

Rent,  under  these  conditions,  is  a  differential  which  measures 
accurately  the  superiority  of  the  rent-bearing  land  over  the  mar- 
ginal land  —  the  land  which  just  repays  the  expenses  of  cultiva- 
tion. It  is  not  necessary  to  the  significance  of  the  theory  that 
all,  or  even  any,  of  the  farmers  should  be  tenant  farmers.  If 
the  farmer  owns  the  land  that  he  operates,  the  part  of  his  income 
to  which  may  be  attributed  the  superiority  of  his  land  over  an 
equal  area  of  marginal  land  must,  in  any  accurate  analysis, 
be  counted  as  rent. 


THE   RENT  OF  LAND 


413 


Rent  under  Actual  Conditions.  —  The  conditions  assumed  in 
the  foregoing  analysis  depart  from  actual  conditions  in  one  im- 
portant particular,  —  the  assumption  that  equal  amounts 
of  labor  and  capital,  that  is,  a  uniform  intensivity  of  cultiva- 
tion, would  be  used  on  lands  of  different  grades.  As  a  matter 
of  fact,  even  after  the  A  lands  are  all  occupied,  the  supply  of 
agricultural  products  can  be  increased  without  resort  to  poorer 
lands.  All  that  is  really  necessary  is  the  more  intensive  culti- 
vation of  the  A  lands.  This  cannot  be  done,  however,  without 
encountering  the  law  of  diminishing  productivity.  Successive 
equal  amounts  of  labor  and  capital  used  on  the  same  lands 
cannot  be  expected  to  yield  uniformly  large  increments  of  prod- 
uct. It  will  pay,  however,  to  make  use  of  more  intensive  culti- 
vation up  to  the  point  where  the  last  unit  of  labor  and  capital 
adds  barely  enough  to  the  prod- 
uct to  pay  for  the  increased 
expense,  —  a  point  which  is  called 
the  intensive  margin.  The  result 
of  this  more  intensive  cultivation 
is  represented  in  Figure  2.  Now 
the  first  rectangle  in  this  diagram 
(Oamy)  represents  precisely  the 
same  thing  as  is  represented  by 
the  first  rectangle  in  Figure  1,  the 
return  (in  value  of  product)  from 
the  cultivation  of  an  acre  of  land 
of  A  grade  by  the  use  of  a  fixed 
amount  of  labor  and  capital.  The  second  rectangle  in  Figure  2, 
however,  represents  the  additional  product  resulting  from  the 
use  of  a  similar  unit  of  labor  and  capital  on  the  same  acre,  while 
the  third  represents  the  increment  of  product  due  to  the  employ- 
ment of  yet  a  third  unit  of  labor  and  capital  on  the  same  land. 
Assume  that  this  third  unit,  An,  adds  just  enough  to  the  selling 
value  of  the  product  to  pay  for  itself.  Then,  as  already  ex- 
plained in  the  discussion  of  diminishing  productivity,  the  area 
Ocph  will  represent  that  part  of  the  farmer's  income  which  will 
be  used  up  by  the  expense  incurred  for  the  three  units  of  labor 


Fig. 


Ai 


4H 


OUTLINES  OF    ECONOMICS 


and  capital  used  on  this  one  acre  of  land,  and  the  area  above 
the  line  hq  will  represent  the  real  rent  of  that  acre.1  If  land  E 
(Figure  i)  just  repays  the  expenses  of  cultivation  when  one  unit 
of  labor  and  capital  is  used  per  acre,  the  value  of  the  product 
per  acre  of  this  land  will  equal  the  value  of  the  increment  of 
product  attributable  to  the  third  unit  of  labor  and  capital  used 
on  land  A.  (That  is,  the  area  dert,  Figure  i,  equals  the  area 
bcpq,  Figure  2.)  So  far,  then,  as  the  margin  of  cultivation  is 
concerned,  Figure  1  represents  the  conditions  accurately.  The 
productivity  of  capital  and  labor  at  the  intensive  and  extensive 
margins  is  the  same. 

But  Figure  1  does  not  represent  the  complete  theory  of  rent 
in  that  (1)  it  does  not  indicate  the  fact  that  larger  quantities 
of  capital  and  labor  are  used  on  the  better  lands  than  on  the 

poorer  lands,  and  (2)  it 
does  not  represent  the 
larger  products  due  to 
this  more  intensive  culti- 
vation of  the  better  lands. 
These  considerations  are 
taken  account  of  in  Fig- 
ure 3,  which  also,  by  the 
substitution  of  curves  for 
successive  rectangles, 
represents  the  infinite  va- 
riety of  degrees  of  good- 
ness of  the  different  acres 
making  up  the  land  sup- 
ply of  a  country.  In  Figure  3  the  line  am  represents  the  money 
value  of  a  product  of  a  unit  of  labor  and  capital  on  the  poorest 
land  in  use,  and  the  area  htni  represents  what  rent  would  be 
under  conditions  of  uniform  intensivity  of  cultivation.  The  area 
Oamg  represents  the  diminishing  amounts  of  labor  and  capital 
used  per  acre  as  we  pass  from  the  better  to  the  poorer  lands, 
while  the  area  ymg  represents  the  rent  per  acre  of  the  different 
grades  of  lands.    The  foregoing  analysis  leads  to  the  following 

1  Neglecting,  for  the  present,  the  possible  existence  of  profits. 


X'IG.  3. 


THE    RENT  OF   LAND  415 

statement  of  the  theory  of  rent,  vhich  the  reader  may  verify 
for  himself  by  referring  to  Figures  t  and  2  : 

The  rent  of  any  piece  of  land  is  measured  by  the  difference  between 
the  money  value  of  the  products  obtained  from  it  by  the  use  of  the 
most  advantageous  amounts  of  labor  and  capital  and  the  money 
value  of  the  products  which  coidd  be  obtained  by  the  use  of  the  same 
amounts  of  labor  and  capital  on  marginal  land,  or  at  the  intensive 
margin  of  cultivation. 

This  statement  should  not  be  understood  as  comparing  the 
total  product  raised  on  a  given  piece  of  land  with  the  total  prod- 
uct which  could  be  got  from  the  same  amount  of  marginal  land. 
This  would  be  to  reintroduce  the  assumption  of  uniform  inten- 
sivity  of  cultivation  —  an  assumption  which  impaired  the  ade- 
quacy of  the  theory  of  rent  illustrated  in  Figure  1  above.  On 
the  contrary,  it  is  assumed  in  the  present  statement  that  the 
farmer  would  use  whatever  amount  of  the  marginal  land  he 
found  most  profitable.  If  it  were  profitable  to  use  twenty 
times  as  much  labor  and  capital  on  a  certain  piece  of  land  as 
on  a  similar  amount  of  marginal  land,  to  employ  the  same 
amount  of  labor  and  capital  profitably  on  marginal  land  would 
take  twenty  times  as  much  land. 

Rent  and  the  Marginal  Product  of  Land.  —  In  an  earlier  chapter  it  was 
suggested  that  rent  could  be  measured  by  the  marginal  product  of  land ;  in 
other  words,  that  the  amount  which  a  farmer  would  pay  per  acre  for  the  use 
of  land  would  depend  upon  the  money  value  of  so  much  of  his  product  as 
was  dependent  upon  the  possession  of  any  one  acre  of  land.  In  that  dis- 
cussion it  was  assumed,  however,  that  land  was  of  a  uniform  degree  of  good- 
ness. Obviously,  if  all  land  really  were  of  a  uniform  degree  of  goodness,  in 
all  ways  equally  desirable,  no  rent  would  be  paid  until  all  lands  were  utilized, 
when  rent  would  arise  on  account  of  the  necessity  of  increased  intensivity  of 
cultivation. 

But  even  under  the  actual  conditions  of  the  existence  of  different  grades  of 
land  and  of  a  large  body  of  land  which  is  below  the  margin  of  cultivation, 
the  rent  of  any  acre  of  the  better  lands  can  be  stated  in  terms  of  the  value 
of  its  product.  For  the  rent  of  any  acre  of  land  is  determined  by  the  money 
value  of  the  amount  of  the  product  imputed  to  it  (as  distinct  from  the  product 
imputed  to  the  labor  and  the  capital  employed  upon  it).  Now  the  product 
that  must  be  imputed  to  any  acre  of  land  is,  of  course,  the  amount  which  it 
adds  to  the  total  product,  or,  what  amounts  to  the  same  thing,  the  amount  by 


41 6  OUTLINES   OF  ECONOMICS 

which  the  total  product  would  be  decreased  if  just  as  much  labor  and  capital 
were  employed  in  agriculture,  but  if  that  particular  acre  of  land  were  not 
available.  This  means,  however,  that  the  labor  and  capital  which  would 
have  been  employed  on  this  land  would  have  to  be  utilized  either  in  cultivat- 
ing more  intensively  the  lands  already  utilized  or  in  cultivating  lands  pre- 
viously uncultivated;  that  is,  at  either  the  intensive  or  extensive  margin. 
Obviously  the  product  imputed  to  the  land  in  question  would  be  the  differ- 
ence between  the  total  product  got  from  it  and  the  product  which  would 
result  from  the  employment  of  the  same  amount  of  labor  and  capital  at  the 
margin.  Thus,  by  a  somewhat  different  line  of  analysis,  we  have  again 
reached  the  statement  of  the  theory  of  rent  given  in  the  preceding  section. 

The  Different  Uses  of  Land.  —  We  have  seen  that  the  better 
lands  will  repay  a  more  intensive  cultivation  than  the  poorer 
lands,  and  have  found  this  fact  to  be  of  great  significance  in  the 
theory  of  rent.  By  varying  degrees  of  intensivity  of  cultivation 
we  do  not  mean  only  the  more  thorough  cultivation  of  the  land 
in  the  raising  of  any  one  crop.  Land  produces  a  great  variety 
of  products,  and  some  of  these  need  much  more  intensive  culti- 
vation than  others.  In  the  business  of  raising  cattle,  as  it  is  con- 
ducted on  a  large  western  ranch,  the  total  investment  of  capi- 
tal and  labor  may  be  very  considerable,  but  the  investment  per 
acre  of  land  is  very  small  indeed ;  while  a  small  market  garden, 
located  near  a  great  city,  will  repay  a  very  high  degree  of  inten- 
sivity of  cultivation.  It  is  only  on  the  best  lands  that  crops 
necessitating  a  large  amount  of  labor  per  acre  can  be  raised 
profitably.  By  the  best  lands  wre  mean  in  this  connection 
not  only  those  lands  which  are  best  fitted  by  soil  and  climate 
for  the  production  of  particular  crops,  but  the  best  lands  in 
the  sense  that  they  are  nearest  the  market.  For  example, 
cities  in  the  eastern  part  of  the  United  States  get  part  of  their 
supply  of  fresh  vegetables  from  market  gardens  in  their  own 
environs,  while  another  part  of  this  supply  may  come  from  the 
southern  states  and  even  across  the  continent  from  California. 
The  local  market  gardens  are  good  lands  on  account  of  their 
situation ;  the  more  distant  lands  are  good  lands  on  account 
of  special  qualities  of  soil  or  climate  which  enable  them  to  furnish 
"  out  of  season  "  vegetables. 

Because  certain  lands  are  adapted,  on  account  of  quality  or 


THE    RENT  OF   LAND  417 

location,  for  intensive  cultivation,  they  command  high  rents. 
On  the  other  hand,  lands  which  command  high  rents  for  alter- 
native uses  generally  have  to  be  cultivated  intensively,  because 
the  entrepreneur  is  forced  by  the  very  fact  of  high  rent  to  econo- 
mize in  his  use  of  land  as  compared  with  his  use  of  capital  and' 
labor.  The  raising  of  flax  as  raw  material  for  linen  is  a  profitable 
agricultural  industry  in  densely  populated  Belgium,  but  it 
has  never  met  with  much  success  in  the  United  States  because 
flax  straw  of  a  quality  fit  for  the  better  grades  of  linen  demands 
a  large  amount  of  care  and  labor.  Land  is  so  plentiful  here 
that  it  pays  us  better  to  specialize  in  a  less  intensive  kind  of 
agriculture  —  to  spread  our  labor  and  capital  more  thinly  over 
a  larger  number  of  acres. 

The  poorest  land  that  can  profitably  be  used  in  the  growing 
of  any  one  kind  of  product  is  not  necessarily  marginal  land. 
Land  too  poor  to  use  for  market  gardening  may  be  good  wheat 
land;  land  too  poor  to  devote  to  wheat  may  be  good  grazing 
land.  The  poorest  land  devoted  to  any  one  purpose  may 
yield  a  rent,  arising  from  its  relative  superiority  over  other 
lands  for  some  alternative  use.  It  will  be  readily  understood 
that  the  marginal  lands  used  as  a  basis  of  comparison  in 
our  statement  of  the  law  of  rent  are  the  poorest  lands  used 
for  any  purpose  —  grazing  lands,  possibly.  But,  as  we  have 
seen,  rent  may  also  be  measured  from  the  intensive  margin  of 
cultivation,  and  the  intensive  margin  is  found  on  all  lands,  even 
the  best. 

Although  all  our  illustrations  of  the  theory  of  rent  have  been 
drawn  from  agriculture,  the  principle  is,  in  fact,  perfectly  gen- 
eral. The  rent  of  land  used  for  industrial  or  commercial  pur- 
poses is  determined  in  precisely  the  same  way  as  the  rent  of 
agricultural  land.  In  fact,  different  kinds  of  manufacturing, 
wholesale  and  retail  trading,  etc.,  may  be  looked  upon  as  dif- 
ferent possible  uses  of  land,  differing  in  the  amount  of  labor 
and  capital  they  require,  and  all  subject  to  the  law  of  diminish- 
ing productivity,  and  hence  to  the  law  of  rent.  When  we  pass 
from  the  agricultural  uses  of  land  to  its  commercial  and  indus- 
trial uses,  the  fact  of  quality  becomes  of  practically  no  impor- 


4lS  OUTLINES   OF   ECONOMICS 

tancc  in  the  determination  of  rent,  while  the  fact  of  location 
becomes  fundamental. 

In  addition  to  these  different  gainful  uses  of  land,  we  have 
to  take  account  of  its  other  uses,  such  as  for  pleasure  grounds 
and  residence  sites.  Here  the  explanation  of  rent  is  simpler 
than  in  the  case  of  productive  lands.  For  these  lands  yield 
their  utilities  directly,  and  hence  come  under  the  general  laws 
of  price. 

The  Capitalization  of  Rent.  —  To  the  individual  who  has  a  cer- 
tain amount  of  money  for  which  he  is  seeking  the  most  profitable 
use,  the  question  whether  he  shall  invest  it  in  land  or  other  forms 
of  production  goods  is  apt  to  be  in  itself  an  unimportant  one. 
If  he  chooses  to  buy  land,  it  will  be  because  he  can  get  a  satis- 
factory income  from  it,  and  he  will  very  properly  count  the 
income  as  interest  on  the  funds  he  has  invested  in  the  land.  If 
the  income  from  the  land  increases,  the  selling  value  of  the 
land  will  increase.  From  the  point  of  view  of  our  investor 
this  will,  of  course,  be  an  increase  in  the  "  capital  value  "  of 
the  land.  It  is  important  to  note,  however,  that  the  land  does 
not  return  an  income  simply  because  it  is  valuable.  The  process 
is  the  reverse  of  this.  The  land  aids  annually  in  the  production 
of  goods  which  command  a  price  in  the  market ;  a  part  of  the 
money  value  of  this  annual  product  is  necessarily  imputed  to 
the  service  of  land  and  paid  for  in  the  form  of  economic  rent ; 
and  the  land  is  valued  because  it  commands  a  rent.  The  money 
value  of  the  land  is  governed  by  its  income-yielding  power. 

This  fundamental  fact  is  apt  to  escape  our  notice  because  in 
the  United  States  lands  are  more  commonly  sold  than  leased,  so 
that  we  think  of  the  price  of  land  as  the  price  at  which  it 
will  sell,  rather  than  as  its  annual  price,  or  rent,  although  the 
first  kind  of  price  depends  upon  the  second.  In  England, 
where  lands  are  more  commonly  leased,  the  price  of  land  is 
usually  thought  of  as  its  annual  price  or  rent,  while  the  selling 
price  is  often  expressed  as  "  twenty  (or  other  number  of)  years' 
purchase,"  meaning  twenty  times  the  annual  rent.  The  process 
by  which  the  capacity  to  yield  a  certain  annual  income  is  made 
the  basis  for  the  determination  of  a  certain  selling  price  is  termed 


THE   RENT  OF  LAND  419 

"  capitalization."  *  In  a  country  which  is  growing  in  popula- 
tion and  wealth,  and  where  land  rents  are  consequently  increas- 
ing, the  selling  value  of  land  is  apt  to  be  somewhat  greater 
than  a  capitalization  of  the  amount  of  income  it  is  yielding  at 
the  time  of  the  sale  would  justify.  This  is  because  the  owner- 
ship of  land  carries  with  it  the  right  to  receive  future  as  well  as 
present  incomes,  and  the  prospectively  larger  future  incomes 
are  taken  into  account  in  the  process  of  capitalization. 

Rent  and  Social  Progress.  —  The  fact  just  mentioned  —  the 
tendency  of  rents  to  increase  as  society  progresses  —  is  of  very 
great  significance.  It  springs  from  the  impossibility  of  satisfy- 
ing the  increasing  wants  of  a  society  which  is  growing  in  popu- 
lation and  wealth  without  increasing  the  supply  of  food  products 
and  raw  materials  by  means  of  more  extensive  and  more  inten- 
sive cultivation.  As  this  means  pushing  downward  the  exten- 
sive and  intensive  margins  of  cultivation,  the  necessary  result 
is  a  rise  in  rents. 

During  the  early  years  of  the  nineteenth  century  the  Napole- 
onic wars  on  the  continent,  together  with  a  high  protective  tariff 
in  England,  kept  England  from  importing  any  grain  from 
Europe.  This,  coupled  with  a  considerable  increase  in  the  popu- 
lation of  England,  resulted  in  very  high  prices  for  wheat,  a 
rapid  extension  of  cultivation,  and  a  remarkable  rise  in  rents. 
It  was  the  effort  of  economists  to  explain  these  facts  that  led  to 
the  formulation  of  the  theory  of  rent  in  substantially  its  present 
form.  Bound  up  with  this  theory  of  rent  was  the  law  of  dimin- 
ishing returns  —  the  name  usually  given  to  the  fact  that  an  in- 
creasing population  cannot  supply  itself  with  food  and  raw 
materials  except  by  the  utilization  of  poorer  and  poorer  lands, 
and  consequently  at  an  increasing  expense  per  unit  of  product. 
(This  law  should  not  be  confused  with  the  law  of  diminishing 

1  The  nature  of  this  process  of  capitalization  will  be  discussed  in  the  chapter 
on  Interest.  It  is  a  fact  of  common  observation  that  the  rate  of  capitalization, 
that  is,  the  ratio  of  income  to  selling  value,  is  lower  in  the  case  of  land  than  in  the 
case  of  most  forms  of  capital  goods.  The  durability  of  land,  the  variety  of  uses 
to  which  it  may  be  put,  the  social  prestige  attached  to  land  ownership,  as  well  as 
the  fact  that  in  many  cases  its  income-yielding  power  is  likely  to  increase,  are  among 
the  things  that  account  for  this. 


420  OUTLINES  OF   ECONOMICS 

productivity.  One  is  a  statement  of  a  historical  tendency  in 
one  field  of  production  —  agriculture ;  the  other  relates  to  the 
proportions  in  which  the  factors  of  production  are  combined, 
and  holds  true  for  all  fields  of  production.) 

This  law  of  diminishing  returns  has  been  made  the  basis  of 
many  gloomy  prophecies  regarding  the  possibilities  of  a  general 
and  continued  economic  progress.  Especially  when  this  theory 
was  combined  with  the  Malthusian  theory  of  population,  which 
was  based  on  the  belief  that  population  would  tend  to  increase 
as  fast  as  the  food  supply  would  permit,  it  seemed  to  point  to 
insuperable  barriers  in  the  way  of  any  considerable  progress  in 
human  welfare. 

The  history  of  the  past  century  has  belied  these  gloomy  proph- 
ecies. The  increase  in  population  has  been  greater  than  in 
any  previous  period  of  the  world's  history,  and  yet,  so  far  as 
agricultural  lands  are  concerned,  the  general  level  of  rents  has 
not  increased.  In  fact,  the  change  has  been  in  the  other  direc- 
tion. That  rents  have  not  increased  as  population  has  grown, 
does  not  disprove  the  law  of  diminishing  returns.  That  law, 
like  other  economic  laws,  is  true  only  as  a  statement  of  a  tend- 
ency. If  this  tendency  has  not  resulted  in  increased  rents,  it 
is  not  because  it  has  not  been  operative,  but  because  other 
powerful  factors  have  counteracted  its  effects.  Two  things, 
at  least,  have  prevented  a  rise  in  rents.  In  the  first  place,  im- 
provements in  agricultural  methods  have  greatly  increased  the 
product  which  can  be  got  from  a  given  acre  of  land.  We  must 
include  here  not  only  improvements  in  methods  of  tillage  and 
cultivation,  in  fertilizers,  in  the  varieties  of  plants,  in  breeds 
of  live  stock,  etc.,  but  also  organized  social  methods  looking 
toward  a  better  utilization  of  the  nation's  land  supply,  such 
as  the  irrigation  of  dry  lands,  and  scientific  forestry,  which 
has  an  important  influence  upon  the  conservation  of  the 
rainfall. 

Of  much  greater  importance,  however,  than  all  these  things 
taken  together,  has  been  the  revolution  in  ocean  and  land 
transportation,  which  has  enormously  increased  the  available 
amount  of  land.    Lands  in  England  have  gone  out  of  cultiva- 


THE   RENT  OF   LAND  42 1 

tion  because  the  railway  and  the  steamship  have  brought  the 
great  wheat  fields  of  America  to  her  very  doors.  Even  in  the 
United  States  the  new  lands  brought  near  to  market  by  the  rail- 
ways have  often  been  of  better  quality  than  the  lands  previously 
cultivated,  so  that  the  margin  of  cultivation  has  gone  up  rather 
than  down.  There  were  2,250,000  acres  of  improved  farming 
lands  in  the  state  of  New  Hampshire  in  1850;  by  1900  this 
acreage  had  shrunk  to  1,075,000.  In  Massachusetts  the  im- 
proved farm  lands  decreased  in  this  period  of  fifty  years  from 
2,135,000  acres  to  1,300,000  acres.  Similar  figures  could  be 
given  for  others  of  the  older  states.  The  diminution  in  the  use 
of  old  lands  may  be  partly  accounted  for  by  their  deterioration 
in  fertility  under  continual  cultivation  without  proper  rotation 
of  crops.  But  this  is  only  a  partial  explanation,  for  any  one 
who  is  familiar  with  the  conditions  knows  that  even  the  most 
careful  tillage  could  not  have  kept  millions  of  acres  of  farm  land 
which  were  once  rent-yielding  from  going  below  the  margin  of 
cultivation,  for  the  simple  reason  that  the  margin  of  cultiva- 
tion rose.  The  railway  practice  of  making  very  much  lower 
rates  per  mile  on  long  hauls  than  on  short  hauls  has  hastened 
this  process,  by  minimizing  the  disadvantages  of  lands  of  good 
quality  situated  at  a  distance  from  the  market. 

The  fact  that  since  the  introduction  of  the  railway  the  margin 
of  cultivation  has  risen  does  not  mean  that  it  has  risen  continu- 
ously, or  that  it  will  continue  to  rise.  There  are  many  who  be- 
lieve that  we  have  only  gained  a  brief  and  already  passing  respite 
from  the  day  when  every  increase  in  the  demand  for  food  prod- 
ucts and  raw  materials  will  be  met  only  with  increasing  diffi- 
culty. It  is  as  dangerous  to  prophesy,  however,  as  it  was  a 
hundred  years  ago.  The  fact  that  there  still  remain  some 
unutilized  lands  of  good  quality  in  what  are  now  out-of-the- 
way  parts  of  the  world  may  prove  to  be  of  less  importance  than 
other  things.  It  is  a  striking  fact  that  in  the  United  States 
today  only  about  half  of  the  land  actually  in  farms  is  culti- 
vated. Some  of  these  uncultivated  portions  of  farms  are  very 
poor  lands,  and  others  are  given  over  to  meadows  and  pastures. 
But  we  venture  to  say  that  what  idle  acreage  exists  is  due  in 


422  OUTLINES  OF  ECONOMICS 

part  to  a  lack  of  correspondence  between  the  historical  condi- 
tions that  have  fixed  the  size  of  farms  and  the  economic  condi- 
tions that  fix  the  number  of  acres  that  can  be  profitably  utilized 
by  one  farmer.  This  unexploited  area  is,  to  that  extent  at 
least,  a  reserve  which  can  be  drawn  upon  as  the  demand  for 
agricultural  products  increases.  Then,  too,  we  are  just  begin- 
ning to  have  some  idea  of  the  improvements  which  scientific 
selection  may  bring  about  in  the  qualities  and  productiveness 
of  different  kinds  of  plants ;  methods  of  fertilization  and  tillage 
are  still  the  subjects  of  fruitful  scientific  inquiry ;  forestry  and 
irrigation  are  yet  in  their  infancy.  Changes  in  demand,  of 
such  a  nature  as  to  make  possible  the  utilization  of  some  lands 
for  the  production  of  crops  for  which  they  are  better  fitted  than 
for  their  present  uses,  are  also  among  the  things  that  may  resist 
the  tendency  toward  a  general  rise  in  rents.  In  fact,  although 
it  is  absurd  to~  suppose  that  the  rent  of  land  will  not  increase 
as  society  continues  to  increase  in  wealth  and  numbers,  it  is 
just  as  absurd  to  make  this  fundamental  tendency  toward  dimin- 
ishing returns  in  agriculture  a  basis  for  pessimistic  views  regard- 
ing the  possibility  of  economic  progress. 

The  Unearned  Increment.  —  When  we  say  that  the  margin  of 
cultivation  has  gone  up,  rather  than  down,  since  1850,  we  do  not 
imply  that  rents  have  not,  in  many  cases,  increased.  The  new 
lands  opened  up  to  use  by  new  railways,  for  example,  are  at  first 
very  cheap  lands,  often  free  lands.  As  they  are  taken  up,  they 
command  higher  and  higher  rents.  Practically  all  of  the  agri- 
cultural lands  now  utilized  in  America  have  had  such  a  history, 
—  even  though  in  some  cases  the  present  rents  are  not  as  high 
as  their  rents  at  some  previous  time.  The  fact  that,  through 
the  change  in  transportation  methods,  the  marginal  farming 
lands  of  today  are  better  lands  than  the  marginal  farming 
lands  of  sixty  years  ago  does  not  affect  the  fact  that  the  sum 
total  of  land  rents,  and  consequently  of  land  values,  is  immensely 
greater  today  than  at  any  previous  time.  The  increase  in 
the  value  of  land  which  accompanies  the  increase  in  its  income- 
yielding  power  is  often  called  the  unearned  increment.  This 
phrase  suggests  that  the  increase  in  land  values  cannot  be 


THE   RENT  OF  LAND  423 

attributed  to  any  special  effort  on  the  part  of  the  owners  of 
Jand,  but  is  due  to  general  social  causes. 

This  does  not  mean  that  the  land-owning  farmer  cannot  in- 
crease the  selling  value  of  his  farm  by  wise  investments  of 
capital ;  but,  remembering  that  rent  is  the  payment  for  the 
irremovable  conditions  affecting  the  productiveness  of  land, 
it  is  clear  that  it  can  be  affected  only  to  a  comparatively  small 
degree  by  the  efforts  of  any  one  individual  landowner.  Most 
of  the  present  money  value  of  land  has  grown  out  of  that 
complex  of  things  which  we  call  general  social  progress,  the 
most  important  of  which  in  this  connection  are  growth  in  popu- 
lation and  growth  in  average  wealth  —  the  things  that  lead  to 
an  increased  demand  for  the  products  of  the  soil.  We  should, 
however,  be  careful  to  distinguish  the  rise  in  the  sum  total  of 
rents  which  springs  from  the  occupation  of  new  and  often  better 
lands,  and  the  increase  in  rent  per  acre,  which  comes  from  forc- 
ing downward  the  margin  of  cultivation. 

Despite  these  facts,  the  phrase  unearned  increment  is  mis- 
leading. As  generally  used,  it  implies  a  confusion  of  two  very 
different  things,  —  physical  quantities  (acres)  and  selling  val- 
ues. From  the  fact  that  land  is,  in  a  physical  sense,  rarely 
"  produced  "  it  is  inferred  that  the  selling  value  of  land  is 
always  "  unearned."  Other  forms  of  wealth,  it  is  sometimes 
urged,  are  valuable  (command  a  high  price)  because  they  are 
produced  at  a  cost ;  land  has  no  "  expenses  of  production," 
and  is  valuable  only  because  there  is  a  demand  for  land  and  for 
its  products.  Now  the  reader  should  be  able  to  see  that  this 
is  not  an  altogether  accurate  way  of  stating  the  case.  Produced 
goods,  like  land,  are  valuable  only  because  people  want  them 
and  are  willing  to  pay  for  them.  Other  things  have  to  be  paid 
for  because  otherwise  it  will  not  be  worth  while  for  any  one  to 
go  to  the  expense  of  producing  them ;  land  commands  a  price 
because  its  supply  is  naturally  limited,  and  because  there  are 
competing  users  of  land  who  can  apportion  the  available  supply 
among  themselves  only  on  the  basis  of  prices  and  rents  corre- 
sponding with  the  advantages  which  particular  units  oi  land 
give  to  their  possessors. 


424  OUTLINES  OF  ECONOMICS 

And  so  far  as  the  increase  in  land  values  can  be  foreseen, 
it  can  rarely  be  "  unearned."  For  the  increase  in  the  selling 
value  of  the  land  will  be  taken  into  account  and  discounted. 
This  occurs  in  two  ways.  In  the  first  place,  the  present 
selling  value  of  such  land  will  be  higher  than  that  of  other 
property  with  similar  annual  income-yielding  power.  Usually 
both  the  seller  and  the  buyer  of  land  will  take  into  account 
the  probable  increase  in  its  selling  value  and  will  count  this 
as  an  additional  gain  or  profit  attached  to  the  possession  of  the 
land.  In  other  words,  the  expected  increment  in  value  will  be 
translated  into  terms  of  present  worth,  and  added  to  what 
would  otherwise  be  the  present  selling  value  of  the  land.  The 
increment,  so  far  as  it  can  be  foreseen,  has  to  be  paid  for.  In 
the  second  place,  it  is  often  incorrect  to  consider  the  expense 
of  buying  and  holding  land  as  a  thing  apart  from  the  other 
expenses  and  gains  of  the  business  enterprise  in  which  the  land 
is  used.  The  man  who  builds  a  house  to  let  takes  into  account, 
(i)  the  expense  of  acquiring  the  land,  (2)  the  expense  of  build- 
ing the  house,  (3)  taxes  and  repairs,  (4)  the  probable  ultimate 
depreciation  of  the  rental  value  of  the  house,  (5)  the  probable 
appreciation  in  the  rental  or  selling  value  of  the  land.  It  is 
common  in  such  operations  to  assume  that  the  fourth  and  fifth 
factors  roughly  offset  each  other.  Most  of  the  "  free  "  land 
distributed  under  the  Homestead  Act  was  acquired  by  men  who 
would  have  thought  their  expected  incomes,  outside  of  the 
probable  increase  in  land  values,  insufficient  to  justify  them  in 
acquiring  and  improving  the  lands.  Any  one  who  has  watched 
the  settlement  of  western  states  and  the  growth  of  American 
cities  knows  that  an  enormous  amount  of  effort  and  sacrifice 
has  been  put  into  improvements  on  land  which  would  not  have 
been  put  forth  if  the  anticipated  increase  in  the  value  of  the 
land  itself  had  not  been  counted  on  as  part  of  the  earned 
reward. 

There  are  unearned  increments,  —  unexpected  and  undis- 
counted  increases  in  the  values  of  land,  and,  for  that  matter, 
in  other  capital  values  as  well.  But  there  are  "  unearned  decre- 
ments," too.     The  extent  to  which  these  really  unearned  incre- 


THE    REXT  OF   LAND  425 

merits  are,  in  the  aggregate,  offset  by  unexpected  and  undis- 
counted  shrinkages  in  land  values  and  other  capital  values  is 
a  matter  upon  which  we  have,  as  yet,  no  adequate  information. 

An  American  reformer,  Henry  George,  converted  a  large  following  to  his 
view  that  all  taxes  should  be  levied  upon  land  values.  This  scheme,  known 
as  the  "single  tax,"  proposes  that  economic  rent  shall  go  to  the  government 
in  lieu  of  taxes  —  a  proceeding  which  would  amount  to  the  government 
ownership  of  land,  and  is  so  understood  by  its  adherents.  The  merits  and 
defects  of  the  single  tax  as  a  scheme  for  raising  public  revenue  will  be  con- 
sidered in  another  place.  Here  we  are  concerned  with  it  simply  as  a  scheme 
of  economic  reform.  Henry  George's  main  argument  was  based  on  the 
alleged  tendency  of  land  to  absorb  all  the  value  due  to  "improvements  in  the 
productive  power  of  labor."  Among  these  improvements  in  the  productive 
power  of  labor  he  included  such  diverse  things  as  "the  growth  of  population, 
the  increase  and  extension  of  exchanges,  the  discoveries  of  science,  the  march 
of  invention,  the  spread  of  education,  the  improvement  of  government,"  etc. 
"Land  being  necessary  to  labor,  and  being  reduced  to  private  ownership, 
every  increase  in  the  productive  power  of  labor  but  increases  rent  —  the 
price  that  labor  must  pay  for  the  opportunity  to  utilize  its  powers,  and  thus 
all  the  advantages  gained  by  the  march  of  progress  go  to  the  owner  of  land, 
and  wages  do  not  increase." 

In  the  first  place,  we  may  object  strongly  to  the  assumption  that  improve- 
ments in  methods  of  production  necessarily  mean  improvements  in  the  "pro- 
ductive power  of  labor"  —  an  assumption  which,  like  the  socialists'  labor 
theory  of  value,  really  begs  the  whole  question.  It  would  be  just  as  reason- 
able to  call  these  things  improvements  in  the  productive  power  of  capital 
or  improvements  in  the  productive  power  of  land.  In  the  second  place,  we 
must  enter  an  emphatic  denial  to  the  statement  that  "all  the  advantages 
gained  by  the  march  of  progress  go  to  the  owner  of  land."  If  the  supply  of 
labor  is  increasing  more  rapidly  than  the  supply  of  land,  it  is  probable  that 
rent  per  acre  will  increase  faster  than  wages  per  laborer;  but  this  does  not 
preclude  an  advance  in  wages. 

It  must  be  remembered,  too,  that  Henry  George  did  not  propose  to  abolish 
rent  —  an  obvious  impossibility  —  but  simply  to  do  away  with  the  private 
receipt  of  rent.  This  would  prevent  the  withholding  of  land  from  use  for 
purely  speculative  purposes;  thus  increase  the  available  supply  of  land, 
and  consequently  lower  rents.  That  such  would  be  the  immediate  result  of 
throwing  all  land  open  to  use  cannot  be  denied.  But  in  the  long  run  it  would 
probably  have  little  effect  on  rent,  as  it  would  simply  lead  to  a  more  rapid 
exploitation  of  the  land.  Land  ownership,  like  any  other  institution,  has 
to  be  judged  from  the  viewpoint  of  general  social  interests.  The  "pride  of 
ownership,"  as  an  incentive  to  accumulation  and  as  a  basis  for  good  citizen- 
ship, cannot  be  lightly  put  aside. 


426  OUTLINES   OF  ECONOMICS 

Urban  Lands.  —  In  the  modern  city  we  have  a  tremendous 
mass  of  land  values  resulting  from  the  concentration  of  a  large 
population  on  a  relatively  small  area.1  All  are  familiar  with 
the  narrow  limits  set  upon  the  wholesale  districts,  the  shopping 
districts,  and  the  financial  districts  in  American  cities.  The 
residence  districts  to  which  the  greatest  social  prestige  attaches 
are  apt  to  be  quite  as  narrowly  restricted.  Improvements  in 
rapid  transit  facilities  enlarge  the  residence  areas  that  are  uti- 
lized by  people  with  moderate  incomes,  but  only  serve  to  increase 
the  congestion  in  the  business  centers.  Much  has  been  said 
in  favor  of  the  special  taxation  of  city  land  values.  Movements 
in  this  direction  have  already  gained  great  strength  in  Europe. 
If  such  taxes  are  to  be  justified,  however,  it  must  be  primarily 
on  grounds  of  fiscal  convenience.  In  urban  lands,  as  elsewhere, 
there  are  true  unearned  increments  and  true  unearned  decre- 
ments, but  it  would  be  going  altogether  too  far  to  name  the  whole 
mass  of  urban  land  values,  enormous  as  it,  unearned  increment. 

QUESTIONS  AND  EXERCISES 

i.  Mai  thus  and  Ricardo  differed  as  to  whether  rent  is  an  addition  to  the 
total  income  of  society.     What  is  the  correct  view? 

2.  An  accepted  doctrine  of  taxation  is  that  landowners  cannot  shift  a  tax 
on  land  values  to  any  one  else  (as  the  tax  on  toabcco  is  shifted  from  the 
manufacturer  to  the  consumer).  Explain  this  on  the  basis  of  the  theory 
of  rent. 

3.  "Rent  does  not  enter  into  the  determination  of  normal  price."  Ex- 
plain the  meaning  of  this  statement. 

REFERENCES 

Carver,  T.  N.     The  Distribution  of  Wealth,  Chap.  v. 

George,  Henry.    Progress  and  Poverty. 

Hurd,  R.  M.     The  Principles  of  City  Land  Values. 

Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Book  vi,  Chaps,  ix,  x. 

Pierson,  N.  G.     Principles  of  Economics,  Vol.  i,  Part  i,  Chap.  ii. 

Ricardo,  DAvro.    Principles  of  Political  Economy  and  Taxation,  Chap.  ii. 

Walker,  F.  A.    Land  and  its  Rent. 

1  The  assessed  value  of  land,  exclusive  of  improvements,  in  the  city  of  New  York, 
amounted  in  1907  to  over  three  and  a  half  billions  of  dollars  —  an  amount  nearly 
twice  as  great  as  the  assessed  value  of  all  the  real  estate,  including  improvements 
in  the  state  of  New  York  outside  of  the  city. 


CHAPTER  XXI 
THE   WAGES    OF   LABOR 

Wages  constitute  the  price  paid  for  the  services  of  labor. 
Under  the  head  of  "  labor  "  we  include  all  the  various  kinds  of 
personal  services  for  which  a  payment  is  made.  Professional 
men  and  salaried  employees  are  wage  earners  in  the  economic 
sense,  though  the  term  is  by  common  usage  generally  restricted 
to  manual  laborers  working  for  daily  or  weekly  payments. 
There  is,  however,  in  society  to-day,  as  every  one  recognizes, 
a  "  laboring  class,"  marked  off  by  lines  that  are  fairly  distinct, 
and  including  the  great  body  of  day  laborers,  factory  hands, 
agricultural  laborers,  men  in  various  trades  requiring  various 
degrees  of  intelligence  and  skill,  employees  in  minor  positions 
in  business  and  mercantile  establishments,  and  the  like.  Some 
of  the  most  important  and  pressing  present-day  economic 
problems  —  the  variety  of  things  that  make  up  what  is  often 
called  the  "  labor  problem  "  —  relate  to  the  economic  position 
of  this  class.  On  this  account  it  becomes  of  special  importance 
to  ascertain  just  what  the  rules  are  that  determine  its  share 
in  the  national  dividend.  In  the  discussion  of  wages,  then,  we 
have  in  mind  primarily  the  income  of  the  "  laboring  class," 
although  most  of  the  principles  that  will  be  developed  apply 
just  as  accurately  to  the  other  incomes  that  must  be  classed 
as  wages  in  the  economic  sense. 

Wages  as  the  Price  of  Labor.  —  The  definition  of  wages 
already  given  suggests  at  once  the  most  important  fact  about 
them :  they  are  the  prices  paid  for  particular  kinds  of  services, 
and  hence  come  under  the  general  laws  of  supply  and  demand. 
So  far  as  the  wages  of  any  one  kind  of  labor  are  concerned,  we 
can  say,  as  we  did  of  the  prices  of  commodities,  that  they  will 
tend  to  be  fixed  at  the  point  where  the  supply  of  that  kind  of 

427 


428  OUTLINES  OF  ECONOMICS 

labor  and  the  demand  for  it  are  in  equilibrium.  But,  as  was 
found  in  the  discussion  of  the  prices  of  commodities,  this  simple 
statement  does  not  take  us  very  far  into  the  analysis  of  the 
problem.  We  want  to  know  why  the  supply  of  labor  and  the 
demand  for  it  are  what  they  are.  We  shall  find,  too,  that  the 
factors  governing  the  supply  and  demand  of  labor  are  in  some 
respects  very  different  from  those  governing  the  supply  and 
demand  of  commodities. 

The  Demand  for  Labor.  —  The  demand  for  labor  is,  in  the 
last  analysis,  a  demand  for  the  products  of  labor.  Labor  does 
not  command  a  price  on  its  own  account,  but  because  it  aids  in 
the  production  of  things  that  satisfy  human  wants.  But  how 
can  we  measure  the  product  of  labor  ?  How  can  we  distinguish 
it  from  the  shares  in  the  total  product  that  are  to  be  attributed 
to  land  and  capital  ?  We  cannot  say  that  the  product  of  labor 
is  to  be  measured  by  the  difference  between  the  total  product 
produced  by  the  cooperation  of  labor,  land,  and  capital  and  the 
product  which  would  be  produced  by  land  and  capital  working 
alone ;  for  this  last  would,  of  course,  be  zero.  The  fact  is,  as 
we  have  seen  in  a  previous  chapter,  that  the  proportion  of  the 
product  that  is  attributed  to  labor  is  determined  by  the  prin- 
ciple of  specific  or  marginal  productivity. 

That  is,  we  cannot  think  of  the  "  product  of  labor,"  except 
as  the  product  of  the  individual  laborers  making  up  the  supply 
of  labor,  and  the  product  of  any  individual  laborer  is  actually 
and  exactly  the  amount  which  he  adds  to  the  total  product 
of  land,  labor,  and  capital ;  in  other  words,  the  amount  by 
which  the  total  product  would  be  decreased  if  the  labor  of  this 
individual  laborer  were  not  utilized.  The  social  demand  for 
the  products  of  labor,  which  is  the  basis  of  the  entrepreneur's 
demand  for  labor,  is  not  a  demand  for  any  vague  abstraction 
like  the  "  product  of  labor  in  general,"  but  is  a  demand  for 
the  concrete  products  due  to  the  activities  of  individual 
laborers. 

We  must  note  also  that  in  the  case  of  labor,  as  in  the  case 
of  commodities,  the  word  "  demand  "  must  not  be  taken  in  a 
loose,  indefinite  sense.     The  demand  for  commodities  means 


THE  WAGES  OF  LABOR  429 

the  quantities  that  will  be  taken  at  certain  definite  prices. 
The  demand  for  labor  does  not  mean  anything  unless  it  is 
understood  to  refer  to  the  number  of  laborers  that  will  be  em- 
ployed in  a  particular  occupation  at  a  certain  wage.  In  a 
given  occupation  at  a  particular  time  wages  might  be  fixed 
at  any  one  of  a  large  number  of  different  possible  points.  The 
higher  the  wage,  the  smaller  will  be  the  number  of  laborers 
that  an  entrepreneur  can  afford  to  employ;  and  that  for  two 
reasons :  In  the  first  place,  the  higher  wages  mean  higher 
expenses  of  production,  and  consequently  higher  prices  will  have 
to  be  charged  for  the  product  —  a  fact  which  will  reduce  the 
quantity  of  the  product  that  can  be  sold  on  the  market,  and 
consequently  reduce  the  demand  for  labor.  In  the  second 
place,  higher  wages  for  labor  will  induce  entrepreneurs  to 
economize  in  the  use  of  labor,  and  to  use  relatively  more  land 
and  capital,  according  to  the  principles  which  have  been  ex- 
plained in  the  discussion  of  diminishing  productivity.  The 
demand  for  any  particular  kind  of  labor  is  thus  influenced 
both  by  variations  in  the  demand  for  the  products  of  that 
particular  kind  of  labor,  and  in  the  proportion  of  the  product 
that  can  be  attributed  to  labor  rather  than  to  land  and  capital. 
In  a  similar  way  the  elasticity  of  the  demand  for  any  kind  of 
labor  —  the  extent  to  which  variations  in  wages  wTill  affect  the 
quantity  of  labor  utilized  —  is  a  complex  function,  being  affected 
not  only  by  the  elasticity  of  the  demand  for  the  particular 
products  produced  by  this  kind  of  labor,  but  also  by  the  readi- 
ness with  which  more  capital  or  more  land,  or  both,  can  be 
substituted  for  labor,  as  labor  becomes  higher  priced.  In  the 
printing  industry,  for  example,  a  rise  in  wages  would  make  it 
profitable  for  employing  printers  to  use  more  labor-saving  ma- 
chinery, such  as  typesetting  and  linotype  machines,  automatic 
press  feeders,  and  the  like.  The  higher  the  wages  of  agricul- 
tural laborers,  the  more  profitable  will  be  the  more  extensive, 
as  compared  with  the  more  intensive,  uses  of  land.  On  the 
other  hand,  the  reader  will  at  once  think  of  many  trades,  such 
as  plumbing,  where  machinery  cannot  be  substituted  for  hand 
labor,  and  where,  consequently,  the  only  elastic  element  in  the 


430  OUTLINES  OF   ECONOMICS 

demand  for  labor  lies  in  the  elasticity  of  the  demand  for  the 
products  of  labor. 

The  Effect  of  Labor-saving  Machinery  on  the  Demand  for  Labor.  In  what 
has  just  been  said  about  the  use  of  machinery  as  a  substitute  for  labor,  we 
have  had  in  mind  only  the  effect  of  changes  of  wages  on  the  relative  amounts 
of  labor  and  of  capital  that  would  be  used  in  any  one  branch  of  production. 
Quite  another  problem,  and  one  of  great  social  importance,  relates  to  the  way 
in  which  the  demand  for  labor  is  affected  by  new  inventions  and  by  the 
introduction  of  new  machine  processes.  The  laborers  themselves  have  often 
looked  at  such  innovations  with  hostility.  When  machinery  first  began  to 
be  used  extensively  in  the  woolen  industry  in  England,  this  opposition  was 
expressed  in  riots  in  which  the  new  machines  were  destroyed,  as  well  as  in 
"proposals  to  impose  legislative  restrictions  on  the  use  of  machines,  so  as  to 
bring  them  to  a  level  with  hand  work,  and  prevent  them  from  doing  the  work 
more  quickly  or  more  cheaply  than  it  could  be  done  by  hand."  l  In  many 
instances  laborers  still  are  inclined  to  view  the  introduction  of  labor-saving 
machinery  as  an  economic  injury  to  themselves.  On  the  other  hand,  there 
are  many  persons  who  claim  that  this  attitude  on  the  part  of  the  laborers  is 
an  evidence  of  shortsightedness,  since  the  inevitable  result  of  machine  pro- 
duction is  to  cheapen  the  prices  of  products  and  thus  to  lower  the  cost  of 
living,  the  net  result  being  an  increase  in  real  wages,  as  contrasted  with 
nominal  or  money  wages. 

This  view  emphasizes  an  important  truth,  and  yet  it  misses  the  real 
point  of  the  laborers'  alleged  grievance.  It  is  true  that  while  the  first  result 
of  the  introduction  of  improved  methods  of  production  is  often  to  bring 
larger  profits  to  those  who  introduce  them  (especially  if  the  new  methods  are 
protected  by  patents),  their  benefits  are  ultimately  diffused  throughout 
society  at  large  in  the  form  of  the  fuller  and  better  satisfaction  of  wants,  and 
the  laboring  class,  as  members  of  society,  share  in  these  advantages.  But 
while  it  is  thus  true  that  such  improvements  ultimately  redound  to  the  benefit 
of  laborers  as  a  class,  it  is  equally  true  that  hardship  to  many  individual 
laborers  is  often  an  immediate  result  of  the  introduction  of  labor-saving  ma- 
chinery. Especially  is  this  true  in  the  case  of  skilled  workmen  in  highly 
specialized  employments,  who  sometimes  find  themselves  suddenly  deprived 
of  the  advantages  of  their  skill,  —  gained  often  by  long  years  of  apprentice- 
ship. To  expect  that  such  men  will  feel  that  they  are  compensated  for  their 
personal  loss  by  the  advantages  ultimately  accruing  to  laborers  as  a  class, 
is  to  ask  too  much  of  the  altruistic  elements  in  human  nature.  Workmen 
have  learned,  however,  from  the  experience  of  the  past  hundred  years,  that 
the  introduction  of  machinery  is  inevitable,  and  in  the  better-organized 
trades  they  are  in  many  cases  pursuing  the  wiser  course  of  trying  to  regulate 
the  conditions  of  the  introduction  of  new  kinds  of  labor-saving  machinery 

2  Cunningham  and  McArthur,  English  Industrial  History,  p.  226 


THE  WAGES  OF  LABOR  43 1 

ai  such  a  way  as  to  diminish  the  hardship  inflicted  on  individual  workingmen. 
Thus,  when  the  linotype  machine  began  to  displace  hand  compositors  in  the 
printing  trade,  the  typographical  union  was  able  to  secure  the  retention  of 
many  hand  compositors  as  linotype  operators,  together  with  a  reduction 
in  the  length  of  the  working  day. 

It  should  be  noted  also  that  the  effect  of  the  introduction  of  machinery 
upon  the  demand  for  labor  varies  in  different  industries,  the  most  important 
factor  in  this  connection  being  the  elasticity  of  the  demand  for  the  products 
of  the  particular  trade  affected.  In  the  case  of  the  linotype  just  mentioned, 
the  lessened  cost  of  composition  made  it  possible  for  newspapers  greatly  to 
increase  their  reading  matter,  so  that  the  actual  reduction  in  the  number  of 
employees  was  small  compared  with  what  might  have  been  expected.  The 
introduction  of  machine  methods  into  the  English  textile  industry  during  the 
period  of  the  Industrial  Revolution  furnishes  an  instructive  example.  The 
change  in  the  methods  of  manufacturing  cotton  cloth  came  just  as  the  in- 
vention of  the  cotton  gin  had  greatly  increased  and  cheapened  the  supply  of 
raw  material.  This,  coupled  with  the  decreased  cost  of  manufacturing,  so 
cheapened  cotton  cloth  (which  had  previously  been  very  expensive)  that  its 
use  was  largely  increased.  In  fact,  a  great  many  more  persons  were  em- 
ployed in  spanning  and  weaving  cotton  soon  after  the  Industrial  Revolution 
than  immediately  before  it.  In  the  woolen  industry,  however,  there  was  no 
such  immediate  increase  in  the  sale  of  the  product,  so  that  many  workers 
were  displaced,  and  had  to  seek  occupations  where  their  specialized  skill  was 
of  no.  avail.  Especially  when  the  occupation  affected  is  a  highly  specialized 
but  relatively  unimportant  one  in  a  series  of  processes  comprised  in  the 
manufacture  of  a  product  the  wage-earning  power  of  the  displaced  laborers 
is  apt  to  be  seriously  diminished. 

The  Supply  of  Labor.  —  It  is  when  we  fix  our  attention 
upon  the  nature  of  the  supply  of  labor  that  differences  be- 
tween the  way  in  which  wages  are  determined  and  the  way  in 
which  the  prices  of  commodities  are  determined  become  most 
noticeable. 

In  the  first  place,  if  we  view  industry  in  general,  we  notice 
that  in  the  case  of  labor  there  cannot  be  much  difference  between 
the  actual  supply  and  what  we  called,  when  discussing  exchange 
value,  the  "  potential  supply."  Labor  is  in  this  particular 
like  the  most  perishable  of  commodities :  the  number  of  work- 
ing days  in  a  man's  life  is  limited,  and  those  that  are  not  sold 
are  irrevocably  gone.  The  laborer  has,  it  is  true,  some  power 
in  the  way  of  "  holding  out  for  higher  wages,"  but  even  this 
power  is  limited  rather  narrowly  by  the  absolute  necessity  of 


432  OUTLINES  OF  ECONOMICS 

making  a  livelihood.     In  the  long  run  small  wages  are  bettei 
than  none.    The  sale  of  labor  is  often  a  forced  sale. 

In  the  second  place,  the  fact  that  labor  is  inseparable  from 
the  person  of  the  laborer  has  important  results.  When  the 
laborer  enters  into  an  agreement  to  work  for  wages,  he  not 
only  sells  his  labor,  but  he  gives  up  a  certain  amount  of  control 
over  his  own  life ;  he  agrees  to  live  and  work  under  conditions  — 
often  unpleasant  ones  —  set  for  him  by  others ;  he  accepts,  in 
short,  all  the  environment  of  his  task,  as  well  as  the  task 
itself. 

Connected  to  some  extent  with  this  last  fact  is  a  third  differ- 
ence —  the  relative  immobility  of  labor.  Commodities  may 
always  be  sent  to  the  market  where  they  will  command  the  best 
price,  but  the  laborer  is  restrained  by  family  ties,  patriotism, 
differences  in  language,  customs,  and  religion,  ignorance,  and 
the  like.  The  result  is  that  variations  in  wages  as  between 
different  countries  or  as  between  different  localities  in  the  same 
country  are  much  greater  than  similar  variations  in  prices. 

The  Relation  of  the  Structure  of  the  Population  to  the  Supply 
of  Labor.  —  We  are  apt  to  take  it  for  granted  that  the  supply 
of  labor  in  different  countries  and  localities  depends  primarily 
on  the  numbers  of  the  population.  This  is,  of  course,  funda- 
mentally true,  but  we  must  also  note  that  the  structure  of  the 
population  is  a  variable  thing,  and  one  that  affects  the  supply 
of  labor.  Over  four  fifths  of  the  persons  employed  in  gainful 
occupations  in  the  United  States  in  1910  were  males  —  a  fact 
which  suggests  that  the  relative  proportions  of  the  sexes  in 
the  population  have  an  important  effect  on  the  supply  of  labor. 
There  are  more  males  than  females  in  the  population  of  the 
United  States,  while  the  reverse  is  true  of  most  European  coun- 
tries, this  difference  being  due  in  large  part  to  the  excess  of 
males  among  our  European  immigrants.  There  are  important 
differences  in  this  respect  between  the  individual  states.  Males 
constitute  nearly  two  thirds  of  the  population  of  Montana 
and  less  than  one  half  of  the  population  of  Massachusetts. 
The  age  composition  of  the  population  must  also  be  taken  into 
account.    The  United  States  census  of  19 10  showed  that  nine 


THE  WAGES  OF   LABOR  433 

tenths  of  the  persons  engaged  in  gainful  occupations  were  be- 
tween 15  and  65  years  of  age  —  comprising  what  is  sometimes 
called  the  "  productive  age  group."  A  larger  proportion  of  the 
population  of  the  United  States  is  between  these  ages  than  is  the 
case  in  most  European  countries  —  a  fact  which  is  due  to  the 
large  number  of  foreign-born  adults  in  our  population.  In  most 
European  countries  a  larger  proportion  of  the  population  is  of 
"  productive  age  "  than  is  true  for  the  native  population  of  the 
United  States.  In  considering  the  effect  of  these  natural  group- 
ings of  the  population  upon  the  supply  of  labor,  we  have  to  also 
take  account  of  differences  in  the  nature  of  industries,  in  national 
or  local  customs,  and  in  the  presence  or  absence  of  legal  restric- 
tions, —  all  of  which  affect  the  number  of  women  and  children 
who  can  be  counted  as  part  of  the  available  supply  of  labor. 
Many  observers  have  suggested  that  the  frequent  holidays 
found  in  the  Latin  countries  of  Europe  form  an  appreciable 
obstacle  in  the  way  of  the  industrial  development  of  those 
countries,  as  they  materially  diminish  the  real  supply  of  labor. 
The  supply  of  labor  is  not,  however,  merely  a  matter  of  the 
number  of  available  laborers ;  it  is  also  conditioned  by  their  effi- 
ciency. The  physical  strength  and  vigor,  industry,  intelligence, 
ingenuity,  and  moral  qualities  of  the  laboring  population  deter- 
mine the  amount  and  kinds  of  work  they  can  do.  These  things 
vary  greatly  as  between  different  races  and  as  between  different 
individuals  of  the  same  race.  They  are  not  entirely  a  matter  of 
heredity,  for  they  can  be  influenced  greatly  by  the  physical  and 
social  environment.  So  far  as  high  wages  mean  more  and  better 
food,  and  improve  the  other  conditions  of  living,  they  tend  to  in- 
crease physical  and  mental  efficiency,  and  thus  to  increase  the 
quantity  and  better  the  quality  of  labor  that  can  be  got  from  a 
given  population.  There  may  often  be,  even  when  we  take  only 
production  into  account,  a  real  economy  in  high  wages.  Public 
education  and  public  activity  in  regard  to  such  matters  as  pure 
foods,  hygienic  conditions  in  homes  and  in  factories,  and  oppor- 
tunities for  wholesome  recreation  tend  to  increase  the  efficiency 
of  labor,  and  might  be  justified  on  this  ground.  The  right  view, 
however,  is  that  such  things  would  be  justified  on  their  own  ac- 


434  OUTLINES  OF  ECONOMICS 

count,  as  tending  to  raise  the  level  of  human  living,  even  if  they 
did  not  increase  human  efficiency. 

The  Relation  of  the  Growth  of  the  Population  to  the  Supply  of 
Labor.  —  Just  as  the  potential  supply  of  commodities  at  any 
given  time  is  determined  largely  by  past  conditions,  so  the 
potential  supply  of  labor  at  any  given  time  is  to  a  very  large 
extent  predetermined.  Subject  to  the  limitations  which  have 
been  mentioned  in  the  preceding  section,  the  supply  of  labor 
is  a  matter  of  the  numbers  of  the  population,  and  the  factors 
affecting  the  growth  of  the  population  are,  from  the  long-time 
point  of  view,  the  most  important  things  determining  the  supply 
of  labor. 

Most  of  the  discussion  of  these  factors  has  centered  around 
the  Malthusian  theory  of  population  —  the  doctrine  that  popu- 
lation tends  to  increase  faster  than  the  food  supply,  and  is 
only  held  back  by  the  actual  pressure  of  famine  and  disease 
(arising  from  an  insufficient  food  supply),  or  by  the  prudential 
motives  which  restrain  men  from  undertaking  the  responsibility 
of  marrying  and  raising  families  upon  incomes  insufficient  to 
provide  the  necessities  of  life.  Just  what  the  first  part  of  this 
doctrine  means  can  be  made  clear  by  referring  to  the  conditions 
in  a  country  like  India,  where  the  population  presses  so  closely 
upon  the  food  supply  that  any  considerable  failure  in  the  rice 
crop  is  sure  to  result  in  famine  and  starvation.  Every  increase 
in  the  food  supply  is  followed  there  by  an  increase  in  the  birth 
rate  and  a  decrease  in  the  death  rate ;  every  diminution  in  the 
food  supply  is  followed  by  a  decrease  in  the  birth  rate  and  an 
increase  in  the  death  rate.  The  frequent  famines  in  India, 
which  have  been  charged  by  some  ignorant  or  prejudiced  ob- 
servers to  neglect  or  incompetence  on  the  part  of  the  British 
government,  are,  in  fact,  absolutely  unpreventable,  so  long  as 
these  conditions  prevail. 

When,  however,  we  fix  our  attention  upon  the  United  States, 
or  England,  or  any  country  possessing  Western  civilization, 
we  notice  some  things  that  do  not  seem  to  harmonize  with  the 
Malthusian  theory.  The  population  does  not  press  so  closely 
upon  the  food  supply  that  any  widespread  suffering  follows  a 


THE   WAGES  OF  LABOR  435 

season  of  poor  crops.  Poverty  seems  to  have  but  little  restric- 
tive effect  on  the  birth  rate,  which  is  generally  higher  among 
the  poorer  classes  than  among  the  well-to-do.  Such  facts  have 
been  cited  by  critics  of  the  Malthusian  theory,  some  of  whom 
have  been  inclined  to  credit  it  with  very  little  economic  sig- 
nificance. Yet  when  we  take  a  broader  view  of  the  facts,  they 
appear  in  quite  a  different  light. 

The  best  estimates  indicate  that  England  did  not  have  over 
five  and  a  half  million  inhabitants  in  1630,  and  yet  overcrowding 
at  home  was  one  of  the  reasons  commonly  given  for  the  policy 
of  colonization  which  England  was  undertaking  at  that  time.  A 
hundred  years  later,  despite  the  growth  of  industry,  and  of 
foreign  and  domestic  trade,  as  well  as  some  important  improve- 
ments in  agricultural  methods,  the  population  had  increased 
to  only  about  6,200,000.  In  1761,  on  the  eve  of  the  Industrial 
Revolution,  the  population  is  estimated  to  have  been  about 
6,7oo,ooo.1  By  1831,  when  the  factory  system  was  thoroughly 
established  (although  England  was  still  trying  to  raise  most 
of  her  own  food  supply),  the  population  had  more  than  doubled, 
amounting  to  about  14,000,000.  Since  that  time  England 
has  developed  her  manufacturing  and  commercial  interests, 
but  has  imported  a  larger  and  larger  proportion  of  her  food 
supply  and  raw  materials  from  newer  countries,  where  land  is 
cheaper.  The  latest  census  of  England  (191 1)  showed  a  popu- 
lation of  36,000,000.  There  is  no  explanation  of  this  remark- 
able growth  in  the  population  of  a  country  which  was  "  over- 
crowded "  in  1630,  other  than  the  obvious  one  implied  in  the 
fact  that  the  opening  up  of  new  countries  and  the  improvements 
in  transportation  have  enormously  increased  the  world's  supply 
of  food  products  and  raw  materials  —  a  considerable  portion 
of  which  England  has  been  able  to  get  for  herself  through  the 
development  of  those  commercial  and  manufacturing  activities 
in  which  her  early  start,  her  situation,  her  coal  and  iron  mines, 
and  her  own  necessities,  have  given  her  a  preeminence. 

The  total  population  of  all  Europe  in  1760  was  probably  not 
over   130,000,000.     In   191 5  it  was  about  450,000,000,   some 

1  For  these  estimates,  see  Census  of  Great  Britain.  18^0.  Vol.  1" 


4^6  OUTLINES   OF  ECONOMICS 

200,000,000  of  this  increase  having  taken  place  since  1820,  and 
about  150,000,000  since  1872.  Account  must  also  be  taken  of 
about  125,000,000  persons  of  European  origin  or  descent  living 
outside  of  Europe  at  the  beginning  of  the  twentieth  century. 
Moreover,  wherever  this  European  expansion  has  carried  West- 
ern civilization  and  industrial  methods,  the  numbers  of  the  native 
population  have  more  often  increased  than  decreased.1  Such, 
for  example,  is  the  case  in  Mexico,  South  America,  the  Philip- 
pines, Java,  India,  and  Egypt.  For  at  least  a  hundred  and  fifty 
years  before  the  opening  of  Japan  to  Western  civilization  its 
population  had  remained  nearly  stationary'.  Since  1871  it  has 
increased  from  33,000,000  to  approximately  53,000,000  (1915). 
The  probability  that  this  great  increase  in  that  part  of  the  world's 
population  which  has  adopted  modern  industrial  methods 
has  come  about  by  a  decrease  in  the  death  rate  rather  than  by 
an  increase  in  the  birth  rate  does  not  alter  the  significance  of 
the  fact  that  these  improved  methods  of  production  and  trans- 
portation have  operated  like  the  release  of  a  spring,2  allowing 
the  natural  tendency  toward  the  increase  of  the  population 
to  work  itself  out  more  fully. 

In  view  of  these  facts  it  is  impossible  to  deny  a  large  amount 
of  significance  to  the  Malthusian  theory  of  population.  Popu- 
lation has  generally  increased  wherever  the  increase  in  wealth 
has  afforded  it  opportunity.  Yet  it  does  not  follow  that  the 
Malthusian  theory  is,  in  its  strictest  interpretation,  true.  Popu- 
lation has  not  increased  as  rapidly  as  wealth  has  increased. 
Average  real  incomes  are  very  much  higher  than  they  were 
before  the  Industrial  Revolution  —  a  statement  that  holds 
true  for  average  real  wages  as  a  particular  form  of  income 
Interpreted  in  the  light  of  the  principle  of  diminishing  produc- 
tivity, this  means  that  population  has  not  increased  so  rapidly 
as  capital  and  the  available  supply  of  land  have  increased.  If 
there  had  been  no  increase  in  population  during  the  last  one 

1  W.  F.  Willcox,  "The  Expansion  of  Europe  in  Population,"  American  Economic 
Review,  Vol.  v,  p.  749. 

1  This  figure  was  applied  to  the  effect  of  an  increase  in  wealth  upon  the  growth  of 
the  population  by  Sir  James  Steuart,  in  his  treatise  on  Political  Economy  (1767). 


THE   WAGES   OF   LABOR  437 

hundred  and  fifty  years,  the  marginal  productivity  of  labor  would 
(if,  nevertheless,  modern  methods  of  production  had  been  de- 
veloped) have  been  very  much  higher  than  it  is,  and  wages 
would  have  been  correspondingly  higher  than  they  are. 

The  Subsistence  Theory  of  Wages.  —  The  doctrine  that 
wages  tend,  in  the  long  run,  to  equal  a  bare  subsistence,  was  a 
theory  advanced  by  English  economists  in  the  first  quarter  of 
the  nineteenth  century  as  a  corollary  of  the  Malthusian  law 
of  population.  Said  Ricardo :  "  The  natural  price  of  labor 
is  that  price  which  is  necessary  to  enable  the  laborers,  one  with 
another,  to  subsist  and  to  perpetuate  their  race,  without  either 
increase  or  diminution."  Granting  the  premises,  the  logic 
was  incontrovertible:  If  wages  fall  below  this  level  of  subsist- 
ence, the  result  will  be,  in  the  long  run,  fewer  laborers  and  there- 
fore higher  wages.  If  the  increase  in  wages  goes  beyond  the 
level  fixed  by  the  cost  of  subsistence,  the  result  will  be,  accord- 
ing to  the  Malthusian  doctrine,  more  laborers  and  therefore 
lower  wages.  The  cost  of  subsistence  in  this  view  formed  the 
"  expenses  of  production  "  of  labor,  and  the  actual  wages 
determined  by  supply  and  demand  were  supposed  to  fluctu- 
ate around  these  normal  wages  as  the  market  prices  of  commodi- 
ties fluctuate  around  the  normal  prices  fixed  by  the  expenses 
of  production.  Socialists  and  advocates  of  the  single  tax  have 
made  much  of  this  theory  of  wages  as  proving  the  impossibility 
of  bettering  the  condition  of  the  laboring  class  under  existing 
conditions.  By  some  socialists  this  doctrine,  in  its  most  rigid 
form,  has  been  called  the  "  iron  law  of  wages."  But  socialists 
and  followers  of  Henry  George  alike  have  to  face  the  difficulty 
of  accepting  this  theory  and  at  the  same  time  rejecting  the  theory 
of  population  on  which  it  rests  —  a  theory  which  they  cannot 
accept,  for  its  truth  would  obviously  place  insuperable  obstacles 
in  the  way  of  any  lasting  improvement  in  wages  being  achieved 
through  the  adoption  of  their  schemes.  The  subsistence  theory 
of  wages,  if  true,  would  hold  just  as  true  under  socialism  or  under 
the  national  ownership  of  land  as  under  existing  conditions. 

It  should  be  said  that  the  subsistence  theory  of  wages  was  in 
part  a  reflex  of  the  conditions  actually  existing  in  England  at  the 


438  OUTLINES   OF   ECONOMICS 

time.  Wages  were  very  low,  and  the  law  required  that  deficien 
cies  in  wages,  below  the  amount  necessary  for  the  maintenance 
of  the  laborer  and  his  family,  should  be  made  up  out  of  parish 
funds  —  a  provision  which  in  itself  tended  to  keep  down  wages, 
and  was  made  still  worse  by  the  fact  that  the  allowance  for 
maintenance  to  each  family  was  proportioned  to  the  size  of  the 
family,  thus  encouraging  the  rapid  increase  of  the  population. 

The  Relation  of  the  Standard  of  Life  to  the  Supply  of  Labor.  — 
Whatever  may  have  been  the  case  in  the  past,  the  subsistence 
theory  of  wages  does  not  square  with  the  facts  of  today,  for  the 
amount  paid  in  wages  is  obviously  considerably  more  than  is 
"  necessary  to  enable  the  laborers  to  subsist  and  to  perpetuate 
their  race,  without  either  increase  or  diminution."  Ricardo 
himself  did  not  give  to  the  "  minimum  of  subsistence  "  the  fixed 
and  rigid  meaning  which  some  socialists  have  attached  to  it. 
It  varied,  he  recognized,  with  the  habits  and  customs  of  the 
people.  In  this  more  elastic  form  the  "  minimum  of  subsist- 
ence "  shades  into  what  is  termed  more  accurately  the  "  stand- 
ard of  life."  The  number  and  character  of  the  wants  which  a 
man  considers  more  important  than  marriage  and  family  constitute 
his  standard  of  life.  Whenever  wages  fall  below  a  point  where 
the  standard  of  life  can  be  maintained  for  a  family,  the  work- 
man will  do  without  the  family  and  maintain  the  standard  of 
life  for  himself  alone.  While  the  increase  in  the  quantity  of 
goods  produced  that  has  taken  place  by  reason  of  the  industrial 
revolution  and  the  utilization  of  new  and  vast  bodies  of  natural 
resources  has  been  attended  with  an  unprecedented  increase 
in  population,  it  has  also  been  attended  with  an  improvement 
in  the  standard  of  living.  Every  advance  in  the  standard  of 
life  marks  a  step  definitely  gained  in  the  economic  progress  of 
the  laboring  class ;  it  affords  a  vantage  ground  for  yet  farther 
progress. 

This  is  not  only  because  the  standard  of  life  is,  by  very  defini- 
tion, a  fundamental  factor  in  determining,  in  the  long  run,  the 
supply  of  labor,  but  also  because  experience  has  shown  that 
the  standard  of  life  affords  an  element  of  strength  to  laborers 
in  their  bargains  with  employers.    Any  encroachments  on  it 


THE   WAGES   OF   LABOR  439 

are  met  with  strong  and  determined  resistance.  Moreover, 
a  high  standard  of  life  is,  as  we  have  seen,  one  of  the  things  that 
make  for  productive  efficiency  on  the  part  of  the  laborer,  and 
hence  tend  to  increase  his  earning  capacity.  Many  persons 
who  are  deeply  interested  in  the  welfare  of  the  laboring  class 
believe  that  the  wisest  philanthropy  is  embodied  in  the  efforts 
that  are  made  to  raise  the  level  of  living.  Among  such  efforts 
are  included  such  things  as  the  work  of  social  settlements, 
public  and  private  movements  to  secure  better  conditions  of 
housing,  municipal  expenditures  for  places  of  public  recreation, 
for  public  libraries,  for  such  things  even  as  clean  and  well- 
lighted  streets ;  and,  above  all,  public  education. 

The  extent  to  which  the  possibility  of  attaining  a  still  higher  standard  of 
living  operates  as  a  restraining  force  upon  the  increase  of  the  population  is 
largely  determined  by  the  extent  to  which  democratic  ideals  are  realized 
in  the  social  organization.  It  is  a  noticeable  fact,  for  example,  that  the  first 
generation  of  immigrants  to  the  United  States  bring  with  them  the  habits  and 
ways  of  living  of  their  European  homes.  So  long  as  simple  standards  of  life 
are  retained  in  connection  with  the  larger  incomes  which  they  are  able  to 
earn  in  this  country,  more  of  them  are  able  to  marry;,  they  are  able  to  marry 
earlier,  and  they  can  raise  larger  families.  But  the  second  generation  grows 
up  in  an  American  environment.  They  attend  our  public  schools,  where  they 
mingle  with  American  children  and  receive  an  American  education.  The 
possibility  of  taking  a  social  and  economic  position  higher  than  that  of  their 
parents  is  opened  up  to  them.  They  become  saturated  with  the  American 
notion  that  each  man  has  a  chance  to  climb  to  the  top  of  the  ladder.  They 
find  here  no  rigid  barriers  separating  social  classes  from  one  another.  "Like 
father,  like  son  "  may  have  been  true  in  Europe ;  here  it  has  no  binding  force. 
Hence  the  birth  rate  among  our  native  population  of  foreign  parentage  is 
very  much  lower  than  the  birth  rate  among  our  foreign-born  population. 

The  Supply  of  Labor  in  Different  Occupations.  —  Just  as  the 
demand  for  labor  on  the  part  of  entrepreneurs  is  not  a  demand 
for  "  labor  in  general,"  but  a  demand  for  specific  kinds  of  labor, 
so  the  supply  of  labor  is  the  supply  of  laborers  who  are  able  and 
willing  to  do  certain  definite  kinds  of  work.  The  supply  of  labor 
in  any  given  occupation  is,  at  any  given  time,  almost  as  rigidly 
fixed  as  is  the  supply  of  labor  in  general.  Laborers  can  usually 
change  from  one  occupation  to  another  only  at  the  loss  of  the 
advantage  of  whatever  specialized  skill  they  may  have  acquired. 


440  OUTLINES   OF  ECONOMICS 

This  is,  however,  a  matter  of  occupations,  not  of  industries. 
There  is,  for  example,  a  wide  range  of  industries  open  to  a  skilled 
mechanic  or  a  stationary  engineer.  But  in  the  skilled  trades 
what  variability  there  is  in  the  supply  (at  any  given  time)  comes 
less  from  any  possibility  of  passing  from  one  trade  to  another 
than  from  the  opportunities  the  more  efficient  and  ambitious 
workmen  have  of  entering  business  on  their  own  account  (that 
is,  of  becoming  entrepreneurs)  or  of  entering  some  calling  where 
general  ability,  rather  than  specialized  skill,  is  the  prime  requi- 
site. The  carpenter  may  become  a  contractor ;  the  skilled 
mechanic  may  become  a  traveling  salesman,  and  this,  very 
likely,  in  some  line  where  his  specialized  skill  will  still  be  of 
some  advantage.  The  options  thus  open  to  the  stronger  mem- 
bers of  each  group  should  not  be  lost  sight  of  in  any  considera- 
tion of  the  forces  tending  to  resist  a  downward  movement  in 
the  wages  paid  in  any  occupation. 

Throughout  the  greater  part  of  American  history  the  most  im- 
portant option  of  this  kind  has  been  due  to  the  existence  of  a 
large  body  of  free  land.  The  mobility  of  labor  in  this  country 
has  been  such  that  it  has  been  impossible  for  wages  to  fall  much 
below  the  amount  which  a  man  could  make  for  himself  by  tak- 
ing up  government  land  on  the  frontier.  Today,  however, 
we  are  confronted  by  a  different  set  of  conditions.  The  frontier 
has  completed  its  journey  across  the  continent,  and  there 
remains  for  the  settler  only  such  land  as  irrigation  may  reclaim 
from  the  arid  regions  of  the  West.  The  wage  earner  will  hence- 
forth be  without  the  strong  support  of  the  economic  alternative 
of  a  living  got  from  free  land. 

When  we  take  the  long-period  point  of  view,  we  find  more  elas- 
ticity in  the  supply  of  labor  in  particular  occupations.  The 
ranks  of  each  trade  are  being  continually  depleted  by  old  age, 
death,  and,  to  some  extent,  by  the  alternatives  open  to  its 
stronger  members.  These  gaps  need  not  be  filled  by  an  incom- 
ing body  of  apprentices  if  the  wages  paid  are  lower  than  the 
wages  in  other  occupations  demanding  a  similar  degree  of  prep- 
aration and  ability.  But  there  is  a  certain  amount  of  inelastic- 
ity even  here,  for  a  variety  of  reasons,  among  which  we  may 


THE   WAGES  OF   LABOR  441 

note :  (1)  the  habit  of  imitation,  which  leads  a  boy  to  enter  the 
same  occupation  his  acquaintances  have  chosen ;  (2)  the  not  in- 
frequent tendency  of  sons  to  enter  their  father's  occupation  \ 
(3)  lack  of  knowledge  or  of  early  appreciation  of  the  relative 
advantages  of  different  employments,  and  (4)  the  fact  that  only 
a  small  number  of  options  may  be  open  to  the  residents  of  a  par- 
ticular territory.  These  facts,  in  turn,  have  an  important  bear- 
ing upon  the  localization  of  industry,  for  industries  are  apt  to 
be  located  in  places  where  there  is  a  present  and  prospective 
supply  of  specially  skilled  labor. 

Differences  in  wages,  together  with  other  factors  just  men- 
tioned, are  not,  however,  the  only  considerations  which  attract 
laborers  to  different  occupations.  Many  economic  writers 
have  observed  that  there  are  differences  in  the  wages  paid  in 
different  employments  which  are  out  of  all  proportion  to  any 
differences  in  the  training  or  the  ability  they  require.  Adam 
Smith  enumerated  five  circumstances  which  "  make  up  for  a 
small  pecuniary  gain  in  some  employments,  and  counterbalance 
a  great  one  in  others."  These  are :  "  I.  The  agreeableness 
or  disagreeableness  of  the  employments  themselves;  II.  The 
easiness  and  cheapness,  or  the  difficulty  and  expense,  of  learn- 
ing them ;  III.  The  constancy  or  inconstancy  of  employment 
in  them ;  IV.  The  small  or  great  trust  which  must  be  reposed 
in  those  who  exercise  them  ;  and  V.  The  probability  or  improb- 
ability of  success  in  them."  These  circumstances  need  expla- 
nation in  two  particulars :  First,  the  agreeableness  or  disagree- 
ableness of  an  employment  is  very  often  a  matter  of  the  social 
standing  attached  to  it.  Many  men  are  doing  clerical  work 
to  whom  some  kind  of  physical  exertion  would  be  both  more 
pleasant  and  more  profitable,  but  who  dislike  to  be  classed 
among  the  "  manual  laborers."  So-called  "  professional  pur- 
suits "  attract  many  men  to  whom  more  lucrative  opportunities, 
requiring  less  special  preparation,  are  open  in  other  employ- 
ments. In  the  second  place,  the  significance  of  these  circum- 
stances is  affected  by  the  fact  that  the  most  poorly  paid  (because 
the  least  efficient)  laborers  are  found  in  the  most  disagreeable 
and  the  most  uncertain  employments. 


442  OUTLINES   OF   ECONOMICS 

The  "Wage  Contract.  —  The  wages  that  a  laborer  actually 
receives  are  determined  by  an  agreement  between  himself  and 
his  employer.  Here  appear  again  those  "  gains  of  bargaining  " 
which  were  mentioned  in  the  discussion  of  the  prices  of  commodi- 
ties. But  in  the  case  of  the  wage  agreement,  if  the  bargain  is 
between  an  employer  and  an  individual  workman,  the  advan- 
tage is  likely  to  be  very  largely  on  one  side.  The  employer  is 
apt  to  know  pretty  accurately  what  he  can  afford  to  pay  the 
laborer ;  he  knows  about  how  much  the  laborer  will  add  to  his 
product,  and  his  knowledge  of  business  conditions  helps  him  to 
estimate  the  value  of  this  added  product.  He  knows  what  it 
would  cost  him  to  get  his  added  product  in  other  ways,  as  by 
paying  some  of  his  present  employees  for  "  overtime  "  work,  or 
possibly  by  speeding  his  machinery  faster.  Moreover,  there 
is  the  possibility,  or  even  probability,  of  getting  some  other 
laborer,  in  case  he  fails  to  come  to  an  agreement  with  the  one 
in  question.  His  experience  as  an  employer  of  laborers  will 
help  him  to  gauge  the  minimum  that  the  laborer  will  accept. 
With  the  laborer  the  situation  is  very  different.  He  can  gauge 
with  less  accuracy  just  how  much  his  services  are  worth  to  the 
employer.  The  minimum  wage  that  he  will  accept  will  be 
governed  by  his  very  limited  power  of  holding  out  for  higher 
wages,  or  by  his  estimate  of  what  he  can  get  in  other  employ- 
ments —  very  few  of  which  may  be  open  to  him.  The  whole 
situation  may  be  expressed  by  the  statement  that  it  is  usually 
a  matter  of  small  importance  to  the  employer  whether  or  not 
he  secures  a  particular  laborer,  while  the  securing  of  a  particu- 
lar employment  is  often  a  matter  of  the  very  greatest  importance 
to  the  laborer.  Under  these  conditions  wages  are  apt  to  be 
fixed  much  closer  to  the  minimum  which  the  laborer  will  take 
than  to  the  maximum  which  the  employer  will  pay.  Where 
laborers  can  bargain  in  groups  rather  than  as  individuals,  their 
disadvantages  are  greatly  lessened.  The  fundamental  motive 
underlying  the  development  of  labor  organizations  has  been  to 
secure  the  advantages  of  collective  bargaining. 


THE  WAGES  OF  LABOR  443 

QUESTIONS  AND  EXERCISES 

1 .  How  far  are  wages  determined  by  the  productivity  of  labor  ?  In  what 
different  ways  do  wages  affect  the  productivity  of  labor?  What  meaning, 
or  meanings,  do  you  attach  to  the  word  "productivity"  in  the  foregoing 
questions? 

2.  Why  are  the  wages  of  men  higher  than  the  wages  of  women  in  the  same 
employments? 

3.  Make  a  short  outline,  or  table,  of  the  factors  determining  the  supply 
and  demand  of  labor. 

4.  Are  wages  paid  as  a  reward  for  the  irksomeness  of  labor?  Are  they 
paid  on  account  of  the  scarcity  of  labor  ? 

5.  Some  economists  have  held  that  "a  demand  for  commodities  is  not  a 
demand  for  labor."    Discuss  this  statement. 

REFERENCES 

Carver,  T.  N.     The  Distribution  of  Wealth,  Chap.  iv. 

Clark,  J.  B.     The  Distribution  of  Wealth,  Chaps,  vii,  via. 

Davidson,  John.     The  Bargain  Theory  of  Wages. 

Fetter,  F.  A.    Principles  of  Economics,  Chaps,  xx— xxvi. 

Flux,  A.  W.    Economic  Principles,  Chap.  viii. 

Marshall,  Alfred,  Principles  of  Economics,  6th  ed.,  Book  vi,  Chaps,  i-v. 

Taussig,  F.  W.     Wages  and  Capital. 

Thompson,  H.  M.     The  Theory  of  Wages. 


CHAPTER  XXII 
LABOR   PROBLEMS 

Types  of  Labor  Organizations.  —  There  are  at  least  three 
distinct  types  of  labor  organizations :  the  Trade  Union,  repre- 
senting a  combination  of  wage  earners  in  a  single  trade  or  two  or 
three  closely  related  trades ;  the  Industrial  Union,  composed  of 
all  kinds  of  wage  earners  working  in  a  given  industry ;  and  the 
mixed  Labor  Union,  made  up  of  wage  earners  from  many  trades 
and  many  industries.  Thus,  the  Brotherhood  of  Locomotive 
Engineers,  strictly  a  trade  union,  makes  no  attempt  to  include 
other  workers  in  the  railway  service ;  the  United  Mine  Workers, 
however,  an  industrial  union,  attempts  to  combine  all  persons 
working  in  and  around  the  mines ;  while  the  Knights  of  Labor, 
in  the  period  of  its  strength  and  prosperity,  fused  all  sorts  and 
conditions  of  workers  in  some  of  its  district  assemblies,  and 
combined  these  assemblies  in  a  closely  knit,  highly  centralized 
national  labor  union. 

The  difference  in  the  structure  of  labor  organizations  colors 
their  policies  and  gives  rise  to  important  problems.  The  trade 
and  industrial  unions  are,  as  we  should  expect,  much  more 
homogeneous,  and  therefore  much  more  efficient  than  the  labor 
unions,  but  they  are  likely  to  be  narrower  in  their  aims  and  more 
selfish  in  their  policies.  The  labor  unions,  on  the  other  hand, 
have  in  the  past  proved  much  less  efficient,  much  more  unwieldy 
and  much  more  disposed  to  make  use  of  cooperation,  political 
action,  and  other  devices  which  are  not  suited  to  associations  of 
wage  earners,  or  at  least  not  easily  handled  by  them. 

For  the  larger  and  more  general  objects  common  to  wage 
workers  as  a  body,  many  of  the  American  unions  have  combined 
in  a  large,  loosely  knit  confederacy,  known  as  the  American  Fed- 
eration of  Labor.     This  organization  interferes  just  as  little  as 

444 


LABOR  PROBLEMS  445 

possible  with  the  constituent  unions,  and  confines  its  activity  to 
securing  favorable  labor  laws,  organizing  trades  in  districts  of  the 
country  in  which  trade  unions  have  heretofore  failed  to  get  a 
start,  rendering  assistance  to  unions  which  are  hard  pushed  in 
strikes  or  other  disputes  with  employers,  encouraging  the  use  of 
union-label  goods,  and,  in  short,  to  furthering  all  those  interests 
which  labor  organizations  have  in  common.  The  membership 
of  the  American  Federation  of  Labor  in  19 14  was  a  little  over 
two  millions. 

The  Economic  Justification  of  Labor  Organizations.  —  The 
question  is  often  asked  why  labor  organizations  are  necessary, 
in  view  of  the  fact  that  wages  are  fixed,  at  least  within  broad 
limits,  by  deep-lying  economic  and  social  forces  which  the  labor 
organization  cannot  effectively  control.  If  wages  depend  upon 
demand  and  supply,  it  is  said,  what  excuse  for  the  troublesome 
and  irritating  trade  union  ? 

The  answer  is  in  part  that  economic  laws  work  themselves 
out  through  men  and  through  organizations  —  they  are  not  self- 
enforcing.  We  have  had  labor  organizations  of  one  kind  and 
another  ever  since  the  wage  system  existed,  and  we  shall  un- 
questionably continue  to  have  such  organizations  unless  the 
wage  system  is  superseded  by  something  more  satisfactory. 

Even  if  we  grant  that  labor  is  in  essentials  a  commodity  whose 
price  is  fixed  by  demand  and  supply,  there  is  still  a  reason  for  the 
labor  organization.  The  supply  of  labor  is  largely  controlled, 
in  the  long  run,  as  we  have  seen,  by  the  standard  of  life ;  and 
one  of  the  great  functions  of  the  labor  organization  is  to 
strengthen  and  advance  the  standard  oi  life.  If  a  great  horde 
of  unorganized  and  unsympathetic  wage  earners  are  continually 
bidding  against  one  another  in  the  labor  market,  each  individual 
endeavoring  to  get  a  little  more  work  by  offering  to  take  a  little 
less  pay,  the  standard  of  living  will  be  subtly  undermined,  "nib- 
bled away,"  as  a  well-known  writer  has  expressed  it.  The  labor 
organization,  by  repressing  the  vicious  activity  of  this  competi- 
tion, by  compelling  its  members  to  offer  the  same  terms  and  abide 
by  common  or  standard  rules,  bulwarks  the  standard  of  life,  and 
gives  it  increased  precision,  increased  power  and  durability.     In 


446  OUTLINES   OF   ECONOMICS 

addition,  most  unions  endeavor  to  exercise  a  more  direct  and 
positive  influence  upon  the  supply  of  labor,  by  limiting  the 
number  of  apprentices,  helpers,  and  other  persons  entering  the 
trade.     These  efforts,  however,  are  not  always  successful. 

Current  economic  doctrine  recognizes  at  least  one  other  legiti- 
mate function  of  the  labor  organization.  In  an  advancing  or 
progressive  state  of  industry  there  must  often  be  some  margin 
between  the  price  of  what  the  laborer  —  under  direction  — 
produces  and  the  wages  he  gets  for  producing  it.  The  employer 
cannot  always  pay  the  worker  the  whole  price  of  that  part  of  the 
product  which  might  be  imputed  to  the  worker's  efforts ;  if  he  did, 
he  would,  in  many  cases,  have  only  what,  in  another  chapter,  we 
have  called  "  minimum  "  profits.  By  stout  resistance  and  skill- 
ful bargaining  it  is  often  possible  for  the  wage  worker  to  get  a 
part  of  that  share  of  the  product  which  would  otherwise  go  to 
the  employer  as  profits.  Of  course,  that  labor  organization  will 
be  most  successful  in  the  long  run  which  increases  the  produc- 
tivity of  its  members,  and  thus  creates  a  larger  product  to  be  dis- 
tributed among  all  the  factors  of  production.  But  even  if  the 
organization  does  not  increase  the  productivity  of  its  members, 
it  has  a  chance  to  improve  their  wages  by  trenching  upon  profits. 
Mere  bargaining,  therefore,  despite  the  operation  of  more 
fundamental  economic  forces,  is  still  exceedingly  important. 
And  the  unorganized  wage  workers,  being  poor  bargainers,  com- 
bine with  their  fellow-workmen,  not  only  to  maintain  a  more 
uniform  price  for  their  labor,  but  in  order  to  procure  the  guidance 
and  assistance  of  an  expert  bargainer  —  the  business  agent  or 
walking  delegate.  The  labor  organization  is  thus  a  commercial 
institution  for  the  sale  of  labor  in  large  quantities ;  its  primary 
function  is  collective  bargaining. 

Labor  Organizations  and  Monopoly.  —  It  is  plain  that  the 
labor  organization  as  a  wholesale  jobber  of  labor  is  essentially 
a  product  of  those  familiar  economic  forces  making  for  large-scale 
commercial  dealings ;  it  is  brother  to  the  trust,  akin  to  the  com- 
bination, and  thus  not  untainted  with  monopoly.  One  of  the 
most  searching  criticisms  directed  against  the  labor  organization 
is  that  it  exhibits  all  the  evil  tendencies  of  monopoly.     The 


LABOR   PROBLEMS  447 

charge  has  some  elements  of  truth.  The  ultimate  aim  of  the 
average  labor  organization  is  to  induce  every  worker  in  the 
industry  to  join  the  union,  so  that  by  monopolizing  the  supply 
of  labor  it  may  control  the  price.  But  in  its  principal  implica- 
tions the  charge  of  monopoly  is  misleading,  because  the  great 
majority  of  unions  do  not  attempt  to  limit  the  number  of  their 
beneficiaries.  They  aim  to  increase  wages,  but  they  are  willing 
and  even  anxious  that  every  member  of  the  craft  should  share 
the  increase.  It  is  rare  for  a  labor  organization  to  exclude  from 
its  ranks  a  number  of  workers  and  then  persecute  them  by  refus- 
ing to  work  with  them  or  treating  them  as  scabs.  Conflicts 
with  non-union  men  are  common,  but  in  a  very  large  majority 
of  cases  every  effort  has  been  made  to  get  these  men  into  the 
union.  An  organization  which  is  constantly  exhorting  its  com- 
petitors to  come  into  the  combination  and  share  its  benefits 
is  at  most  an  inclusive  monopoly,  and  is  not  to  be  confused  with 
the  exclusive  monopolies  found  in  the  field  of  business. 

Methods  and  Policies  of  Labor  Organizations.  —  The  aims  of 
labor  organizations  and  the  policies  employed  to  achieve  their 
ends  vary  in  accordance  with  the  conditions  of  the  occupation  or 
industry  in  which  their  members  work.  Some  unions,  for  in- 
stance, lay  great  emphasis  upon  apprenticeship  ;  and  if  they  thus 
secure  control  of  the  supply  of  labor  in  the  trade,  find  it  necessary 
to  place  but  little  dependence  upon  strikes  and  boycotts.  On  the 
other  hand,  organizations  like  the  Brotherhood  of  Locomotive 
Engineers  find  this  question  settled  for  them ;  no  one  can  per- 
form the  work  of  a  locomotive  engineer  without  preliminary 
training,  and  this  natural  limitation  of  the  number  of  trained 
locomotive  engineers  makes  it  possible  for  their  union  to  get 
along  without  maintaining  either  apprenticeship  regulations  or 
the  policy  of  the  closed  shop.1  And  it  rarely  places  dependence 
upon  the  strike.    An  admirable  system  of  mutual  insurance  and 

1  The  familiar  union  rule  prohibiting  members  of  the  union  from  working  with 
non-union  men.  The  policy  is  very  elastic.  No  objection  is  made  to  working  with 
members  of  an  occupation  not  yet  organized ;  some  unions  apply  the  ban  only  to 
non-union  men  in  the  same  trade  or  craft ;  while  others  practically  refuse  to  work 
for  an  employer  who  hires  any  non-union  men  at  all  (not  applying  the  term 
"non-union  men"  to  laborers,  porters,  and  other  unorganized  workers). 


448  OUTLINES  OF  ECONOMICS 

simple  collective  bargaining  is  usually  sufficient  to  keep  the 
membership  loyal  and  obtain  from  employers  fair  rates  of  pay. 

In  the  unskilled  trades,  on  the  other  hand,  where  a  period  of 
apprenticeship  is  wholly  superfluous,  some  more  artificial  protec- 
tion of  the  standard  of  life  is  employed,  like  the  "  policy  of 
the  closed  shop  "  ;  and  this  naturally  forces  the  union,  in  turn,  to 
place  great  dependence  upon  the  strike  and  boycott.  Before 
condemning  a  union  for  employing  some  of  these  policies,  there- 
fore, or  contrasting  it  unfavorably  with  highly  conservative 
unions,  like  the  railway  brotherhoods,  it  is  necessary  to  inquire 
whether  or  not,  like  the  railway  brotherhoods,  it  is  protected 
by  some  natural  condition  of  the  business  which  makes  peace- 
able collective  bargaining  comparatively  easy. 

The  Problem  of  the  Closed-Shop  Policy.  —  It  is  impossible 
to  pass  any  general  verdict  upon  the  justice  of  the  closed-shop 
policy.  Most  Americans  are  inclined  to  condemn  it  offhand  as 
an  attempt  to  deprive  the  non-union  man  of  his  "  sacred  right 
to  work."  They  forget  that  the  union  man  enforces  the  closed- 
shop  policy  for  an  exercise  of  his  "  sacred  right  of  quitting  work." 
Except  where  violence  is  employed,  the  union  which  is  attempt- 
ing to  enforce  a  closed-shop  policy  threatens  to  do  nothing  worse 
than  direct  its  members  to  quit  the  employment  of  the  proprietor 
of  the  open  shop  in  question.  Two  equally  "  sacred  and  inalien- 
able rights  "  clash  in  this  contest,  and  it  is  plain  that  no  decision 
concerning  the  legitimacy  of  the  closed-shop  policy  can  be  deter- 
mined offhand  by  applying  the  touchstone  of  individual  rights. 
If  we  would  know  whether  a  strike  against  non-union  men  is  jus- 
tifiable or  unjustifiable,  we  must  inquire  into  all  the  surrounding 
circumstances  and  the  manner  in  which  the  strike  is  conducted. 
If  the  strike  is  conducted  peaceably,  and  if  the  union  in  question 
is  an  open  union,  cordially  inviting  the  "  scabs  "  to  enter  and 
share  its  benefits ;  if  the  rate  of  wages  and  other  conditions  of 
employment  demanded  by  the  union  men  are  reasonable  in  view 
of  the  cost  of  living  and  other  similar  conditions ;  if  the  "  scabs  " 
involved,  by  accepting  less  than  a  living  wage  or  other  harmful 
conditions  of  employment,  are  working  —  even  though  of  neces- 
sity —  to  undermine  the  American  standard  of  living ;  then  we 


LABOR   PROBLEMS  449 

have  no  hesitation  in  saying  that  the  employment  of  the  closed- 
shop  policy  on  the  part  of  the  union  is  thoroughly  justifiable. 
So  far  as  the  law  is  concerned  the  Supreme  Court  of  the  United 
States  has  decided  that  an  employer  —  perhaps  a  large  corpora- 
tion —  may  discharge  an  employee  for  belonging  to  a  union,  for 
any  reason  or  for  no  reason ;  and  a  recent  act  of  Congress  em- 
powers combinations  of  workingmen  to  do  in  trade  disputes 
anything  which  they  might  lawfully  do  as  individuals.  The 
law  —  or  federal  law  at  least  —  is  apparently  impartial.  But 
from  the  standpoint  of  equity  and  morals  employers  frequently 
discharge  men  for  indefensible  reasons  and  unions  frequently 
attempt  to  enforce  the  closed-shop  rule  for  purposes  or  by 
methods  which  deserve  to  be  condemned. 

We  must  not  confine  our  attention  wholly  to  the  injury  done 
to  the  non-union  man.  The  non-union  man  frequently  does  a 
real  injury  to  his  fellow-workers  by  accepting  wages  or  other 
conditions  of  employment  that  are  inconsistent  with  the  Ameri- 
can mode  of  living.  The  price  cutter  in  the  labor  market  is  not 
ordinarily  a  social  benefactor.  The  weakest,  dullest,  and  least 
enterprising  laborer  exerts  an  influence  upon  the  general  level  of 
wages  out  of  all  proportion  to  his  importance  or  his  deserts. 
If  this  be  true,  the  man  who  cuts  the  standard  rate  of  wages 
may  do  a  grave  social  injury,  and  there  is  justification  for  those 
who  peaceably  combine  to  prevent  him  from  doing  his  destruc- 
tive work.  It  must  be  remembered,  however,  that  these  con- 
clusions are  based  upon  the  assumption  that  the  union  is  an  open 
union  and  that  the  strike  is  conducted  without  intimidation  or 
interference  with  the  non-union  men.  The  moment  the  union 
stoops  to  violence,  that  moment  it  loses  all  claim  to  the  support  of 
an  enlightened  public  opinion. 

Limitation  of  Output.  —  Another  policy  which  is  generally, 
and  in  many  cases  unjustly,  condemned  is  the  regulation  of  out- 
put, systematically  practiced  and  indorsed  by  most  unions. 
The  output  of  the  worker  is  limited  in  many  ways.  The  reduc- 
tion of  the  hours  of  labor,  the  limitation  of  wages  which  some 
unions  working  by  the  piece  system  enforce,  the  prohibition  or 
penalization  of  overtime,  all  operate  to  check  the  activity  cr 


45°  OUTLINES  OF   ECONOMICS 

reduce  the  output  of  the  particular  workman.  Here,  again, 
it  is  unsafe  to  render  any  general  verdict  upon  the  legitimacy  of 
the  policy  in  question.  In  some  industries  in  which  the  piece 
system  is  employed,  the  rate  per  piece  has  unquestionably  been 
forced  down  and  the  workers  spurred  to  excessive  exertion  by  the 
pressure  and  influence  of  pacemakers  or  taskmasters,  paid  by 
the  employers  to  urge  the  workers  to  the  utmost  speed.  Where 
such  conditions  prevail,  no  one  can  successfully  question  the 
justice  of  the  feeling  which  leads  the  union  to  object  to  the 
presence  of  pacemakers  and  to  prescribe  a  maximum  wage  — 
usually  above  that  secured  by  the  average  workman  —  which 
union  members  are  not  permitted  to  exceed.  In  general,  it  is 
plain  that  an  individual  laborer  may  underbid  a  competitor  by 
working  more  intensely,  as  well  as  by  offering  to  work  longer 
hours  or  at  lower  pay.  On  this  account  alone,  trade'  unions 
are  justified  in  defining  and  maintaining  some  regular  pace  or 
standard  intensity  of  work.  Without  such  definition,  collective 
bargaining  would  be  impossible.  This  last  observation,  it  will 
be  noted,  applies  only  to  trades  working  by  the  day.  But  even 
where  the  piece  system  is  used,  the  workers  may  be  justified  in 
fixing  a  liberal  limit  to  the  amount  of  piecework  which  the  wage 
earner  shall  be  permitted  to  do  in  a  day.  For  there  can  be  no 
question  that  unregulated  piecework  does  stimulate  the  worker 
to  excessive  exertion,  and  that  as  daily  earnings  under  the  piece 
system  tend  to  rise,  the  employer  is  tempted  to  reduce  the  rates. 
Some  methods  of  restriction,  however,  are  wholly  vicious. 
The  Journeyman  Stone  Cutters'  Union,  for  instance,  stoutly 
resisted  for  years  the  application  of  machinery  to  their  work,  and 
actually  attempted  to  prevent  the  shipment  of  machine-planed 
stone  into  any  city  where  the  union  had  succeeded  in  preventing 
the  introduction  of  planers.  Such  an  attitude  toward  the  intro- 
duction of  labor-saving  devices  deserves  the  severest  condemna- 
tion. Moreover,  in  some  unions  there  is  a  tacit  approval  of  the 
"  go-easy  "  system,  the  system  of  "  soldiering,"  or  "  adulterat- 
ing labor,"  as  it  has  been  aptly  termed.  Such  a  method  of 
restricting  output  not  only  corrupts  the  character  of  the  indi- 
vidual workman  who  practices  it,  but  makes  it  impossible  for 


LABOR   PROBLEMS  45 1 

the  employer  to  deal  with  the  union  as  a  seller  of  honest  goods, 
and  in  this  way  tends  to  undermine  the  whole  foundation  of 
trade  unionism,  which  is,  as  has  been  said,  collective  bargaining. 
On  the  other  hand,  there  is  no  particular  reason  to  believe  that 
union  labor  is  especially  given  to  "  go-easy  "  habits  of  work. 
The  habit  of  stealthy  loafing  is  found  at  its  worst  in  certain 
unorganized  trades  or  occupations,  so  that  when  it  appears 
among  union  workmen  it  cannot  logically  be  attributed  to 
organization  alone. 

Educational  and  Fraternal  Activities.  —  Practically  all  unions 
have  important  educational  and  social  activities.  .  Debate  upon 
economic  topics  is  common  in  union  meetings,  particularly  at  the 
conventions  of  the  state  and  national  organizations.  It  has  even 
been  said  by  observers  in  close  contact  with  the  facts  that 
foreign-born  wage  earners  receive  their  most  helpful  and  vital 
education  in  American  public  questions  through  the  agency  of 
the  union.  This  broad  education,  which  is  a  most  important 
factor  in  elevating  the  standard  of  life,  is  supplemented  by 
the  social  activities  of  the  labor  organization.  Many  unions 
maintain  a  so-called  "  Ladies'  Auxiliary,"  in  which  the  wives 
of  the  members  participate ;  give  concerts,  dances,  and  other 
social  entertainments,  maintain  charitable  activities,  and  by 
general  social  intercourse  operate  to  unify  and  solidify  the  stand- 
ard of  life  of  the  wage-earning  group  concerned. 

Closely  allied  with  these  educational  and  social  features  is  the 
system  of  insurance  benefits,  which  has  played  a  very  prominent 
part  in  the  development  of  labor  organizations.  In  Great  Britain 
fully  three  times  as  much  money  is  expended  by  the  unions 
upon  mutual  insurance  of  various  kinds  as  upon  administrative 
activities,  or  for  the  support  and  encouragement  of  strikes. 
Union  insurance  is  helpful,  not  only  in  stimulating  thrift  among 
the  individual  members,  but  in  making  the  union  more  careful 
and  conservative  in  its  policies.  Moreover,  it  serves  to  keep 
in  the  union  a  large  number  of  members,  who,  if  they  had  no 
financial  stake  in  continued  membership,  would  drop  out  of  the 
union  in  times  of  peace,  when  no  apparent  advantage  was  to 
be  derived  from  the  union.     All  things  considered,  the  Cigar 


452  OUTLINES   OF   ECONOMICS 

Makers'  International  Union  has  many  claims  to  be  considered 
the  most  successful  American  labor  organization ;  and  its  suc- 
cess is  in  a  large  degree,  if  not  in  the  largest  degree,  attributable 
to  its  wise  and  extensive  use  of  mutual  insurance.  But  on  the 
whole,  the  American  unions  make  relatively  little  use  of  the 
insurance  benefit.  Most  of  them  pay  strike  benefits,  —  that  is 
part  of  their  fighting  policy,  —  and  perhaps  a  majority  of  them 
pay  funeral  benefits,  while  a  respectable  majority  pay  sick 
benefits.  But  the  employment  of  the  superannuation,  accident, 
traveling,  or  "  out-of-work  "  benefit  is  comparatively  rare.  The 
great  majority  of  American  unions  are  militant  in  character, 
existing  primarily  for  the  purpose  of  collective  bargaining,  and 
placing  the  greatest  reliance  upon  the  policy  of  the  closed  shop 
and  the  strike. 

The  Strike.  —  Probab'v  the  most  important  weapon  of  the 
trade  uni^n  is  the  strike.  Unfortunately,  also;  the  weapon  is 
far  too  frequently  used.  Several  generations  ago  most  trade 
unions,  while  they  vehemently  defended  their  right  to  strike, 
cordially  indorsed  arbitration  and  apparently  looked  upon  the 
strike  as  a  weapon  of  last  resort.  Today,  the  average  trade 
union  is  at  best  only  a  lukewarm  advocate  of  arbitration,  while 
it  has  come  to  regard  striking  as  a  permanent  policy.  The  net 
result  has  been  to  commercialize  the  strike,  as  it  were.  Instead 
of  being  a  more  or  less  spontaneous  outburst  against  conditions 
which  the  workingman  regarded  as  unrighteous  and  oppressive, 
the  strike  has  come  to  be  a  commonplace  method  of  bettering 
conditions  of  employment ;  a  device  to  be  employed  when  con- 
ditions are  favorable,  to  be  laid  aside  when  conditions  are 
unfavorable,  but  to  be  used  without  regard  to  ethical  considera- 
tion when  its  use  appears  to  be  profitable. 

The  statistics  of  strikes  published  in  the  Twenty-first  A  nnual  Report  of  the 
(United  States)  Commissioner  of  Labor,  in  the  recurrent  reports  on  strikes 
and  lockouts  of  the  Massachusetts  Bureau  of  Labor  Statistics,  and  in  similar 
reports  of  other  state  labor  bureaus,  indicate  that  strikes  are  steadily  increas- 
ing in  the  United  States.  Moreover,  comparison  of  the  number  of  employees 
thrown  out  of  work  with  the  general  wage-earning  population  indicates, 
although  not  so  certainly,  that  the  proportion  of  workingmen  annually 
involved  in  strikes  has  been  slowly  increasing.    Precisely  what  is  responsible 


LABOR   PROBLEMS  453 

for  this  increase  in  strikes  is  difficult  to  determine.  The  change  in  the 
attitude  of  labor  organizations  toward  the  strike  is  an  important  factor,  no 
doubt.  But  the  greatest  reason  for  the  increase,  in  all  probability,  is  the 
rapid  growth  of  organized  labor.  New  unions  are  prone  to  strike.  The 
sudden  realization  of  their  new  power,  and  the  accumulation  of  strike  funds, 
tempt  them  to  try  their  wings.  In  the  long  run  organization  probably  exerts 
a  conservative  and  steadying  influence :  national  machinery  is  created  which 
curbs  the  capricious  impulses  of  the  local  unions;  experienced  men  are 
usually  elected  to  the  more  important  national  offices,  and  when  they  are 
called  in  to  settle  a  local  grievance,  they  arrive  upon  the  scene  of  action 
without  personal  resentment  against  the  employers  involved.  These  facts 
create  a  strong  hope,  and,  indeed,  a  confident  belief,  among  many  of  those  who 
have  studied  the  labor  question,  that  when  practically  all  American  trades 
are  organized,  strikes  will  steadily  decrease,  as  they  have  in  England,  where 
a  much  larger  part  of  the  wage-earning  population  is  organized  than  in  this 
country. 

Labor  leaders  maintain  that  strikes  strengthen  the  solidarity  of 
the  unions,  and  encourage  the  members  to  make  personal  sacri- 
fices for  the  common  good,  while  they  force  employers  to  respect 
the  strength  of  organized  labor,  and  are  not,  in  the  long  run,  par- 
ticularly costly.  The  time  lost  in  strikes,  they  say,  largely  takes 
the  place  of  enforced  vacations  —  seasonal  stoppages,  and  other 
kinds  of  unemployment  with  which  the  average  wage  earner  is 
normally  visited  during  the  course  of  the  year's  work.  No 
amount  of  such  dialectic,  however,  can  argue  out  of  existence  the 
injury  and  destruction  resulting  from  strikes.  Many  strikes  are 
gravely  injurious  to  the  wage  earners  themselves ;  and  almost 
all  strikes  injure  employers  and  the  consuming  public.  From 
the  social  standpoint  the  strike  is  an  evil,  and  all  justifiable 
means  should  be  employed  to  prevent  its  occurrence. 

We  must  not  conclude,  however,  that  workingmen  and  labor 
organizations  are  wholly  responsible  for  strikes.  If  a  body  of 
men  agree  not  to  work  for  a  given  employer  unless  that  employer 
complies  with  certain  conditions,  whose  fault  is  it  if  the  employer 
refuses  to  comply  and  a  strike  follows?  Very  evidently  the 
fault  may  lie  with  either  the  master  or  the  men,  or  with  both. 
The  fault  lies  with  the  men  if  the  conditions  which  they  demand 
are,  in  view  of  all  the  circumstances,  unreasonable  and  extortion- 
ate.   The  fault  lies  with  the  employer  if  he  refuses  to  grant 


454  OUTLINES  OF   ECONOMICS 

reasonable  conditions  of  employment.  Sometimes  the  fault  is 
with  one,  sometimes  with  the  other ;  sometimes  the  one  gains 
by  the  strike,  sometimes  the  other;  but  the  public,  which  is 
never  at  fault,  stands  always  to  lose.  The  greatest  lesson  to 
be  derived  from  a  consideration  of  strikes  is  the  necessity  of  their 
suppression  in  the  interest  of  the  general  public. 

One  of  the  greatest  evils  attendant  upon  the  strike  is  violence  emanating 
from  both  sides,  —  from  employers'  associations  as  well  as  from  labor  unions. 
It  is  frequently  said  that  this  is  diminishing  with  the  passage  of  years.  The 
statement  is  both  true  and  untrue.  A  study  of  labor  disputes  in  the  early 
period  of  the  modern  labor  movement  seems  to  show  that  the  average  strike 
of  that  period  was  attended  with  much  more  violence  than  the  average  strike 
of  today.  Most  labor  leaders  have  thoroughly  learned  the  lesson  that 
violence  does  not  pay,  and  they  exert  every  effort  to  suppress  it.  But  at  the 
same  time  the  average  strike  of  the  present  time  is  attended  with  some 
violence  or  coercion,  and  the  steady  increase  in  the  number  of  strikes  makes 
the  aggregate  amount  of  violence  now  greater  than  it  was  in  the  past. 

Historically,  also,  a  marked  change  has  shown  itself  in  the  character  of 
the  violence  employed.  In  the  past,  labor  lawlessness  was  more  or  less 
sporadic;  brutal,  it  is  true,  but  frank  and  unpremeditated.  The  lawless- 
ness of  today,  however,  has  taken  on  a  far  more  sinister  form ;  it  has  become 
deliberate,  premeditated,  in  many  cases  official.  The  outrages  perpetrated 
by  the  officers  of  the  International  Union  of  Bridge  and  Structural  Iron- 
workers (the  "dynamite  conspiracy")  and  the  whole  labor  history  of  the 
mining  industry  in  Colorado  and  Idaho  make  it  plain  that  there  has  been  a 
certain  amount  of  carefully  planned  violence  perpetrated  with  the  passive 
consent,  if  not  with  the  active  encouragement,  of  union  officials  and  members. 
There  can  be  no  doubt,  also,  that  individual  employers  and  employers' 
associations  have  stooped  to  equally  reprehensible  practices.  They  have 
employed  as  watchmen  or  detectives  ex-convicts,  thugs,  and  professional 
bad  men,  who  unquestionably  have  not  refrained  at  times  from  perpetrating 
violence  in  order  to  cast  discredit  upon  the  unions.  It  is  impossible  to  con- 
clude which  side  is  the  more  to  blame.  The  lesson  to  be  drawn  is  the  public 
necessity  of  suppressing  and  punishing  violence  or  intimidation  when  prac- 
ticed by  either  side  of  the  controversy. 

Employers'  Associations.  —  The  development  of  modern  em- 
ployers' associations  has  been  briefly  described  in  an  earlier 
chapter.  Their  activities  give  rise  to  a  movement  which  may 
be  briefly  described  as  an  anti-labor  movement.  They  are,  in 
almost  every  respect,  the  natural  foil  and  counterpoise  of  the 
labor  organization.     They  resemble  the  association  of  laborers 


LABOR   PROBLEMS  455 

even  in  structure.  Thus  we  have  had  employers'  associations 
recruited  entirely  from  one  industry,  such  as  the  Stove  Founders' 
National  Defense  Association ;  associations  of  employers  in 
distinct  but  related  industries,  such  as  the  national  Metal  Trade 
Association ;  and  mixed  associations  in  which  all  kinds  of  em- 
ployers are  united,  such  as  the  Citizens'  Alliances,  so  common 
a  few  years  ago  in  many  of  the  Western  cities.  To  complete  the 
analogy,  these  associations  frequently  combined  in  city,  state, 
and  national  federations ;  thus  forming  large  confederacies, 
similar  in  scope  and  activity  to  the  state  and  national  federation 
of  labor.  Speaking  generally,  employers'  associations  show  less 
permanence  than  trade  unions  and  many  of  the  employers' 
associations  which  were  active  a  decade  ago  are  now  moribund. 

We  find  the  same  resemblances  between  employers'  associa- 
tions and  labor  organizations  when  we  examine  the  policies  and 
aims  of  the  former.  Thus  they  make  frequent  use  of  the  lock- 
out. The  Stove  Founders'  National  Defense  Association,  for 
example,  began  its  interesting  career  with  a  lockout  of  the  iron 
molders  in  the  employ  of  its  members.  Like  the  trade  unions, 
also,  they  have  their  legislative  committees  or  lobbies,  and  are 
credited,  for  instance,  with  having  played  an  important  part 
in  defeating  the  eight-hour  and  anti-injunction  bills  which 
have  been  before  Congress  several  times.  Some  of  these  or- 
ganizations also  maintain  so-called  labor  bureaus,  whose  func- 
tion it  is  to  secure  accurate  information  of  the  workmen  in  the 
trade,  so  that  troublesome  agitators  may  be  refused  employment ; 
and  the  methods  employed  in  this  branch  of  the  work  give  rise 
to  something  closely  akin  to  the  "  unfair  list "  published  by 
many  national  unions.  Some  of  the  more  radical  associations 
have  stooped  at  times  to  violence  and  coercion,  as  was  illustrated 
in  1904  by  the  employers'  associations  of  the  Cripple  Creek 
district  which  boycotted  business  firms,  forced  public  officials 
to  resign  by  threats  or  violence,  and  filled  the  vacant  places  with 
their  own  adherents. 

Some  of  the  employers'  associations  are  conservative  in  tone 
and  policy,  working  harmoniously  with  the  labor  organizations 
in  the  industry,  and  going  no  farther  than  to  endeavor  by  every 


456  OUTLINES  OF   ECONOMICS 

legitimate  measure  to  further  the  interest  of  the  affiliated  em- 
ployers. Such  associations  are  exceedingly  helpful  in  furthering 
that  regime  of  peaceable  collective  bargaining  to  which  most 
students  of  this  subject  look  forward  as  the  ultimate  outcome 
of  present-day  tendencies.  They  are  thus  doing  in  an  effective 
way  the  work  of  industrial  peace.  Another  group,  however, 
while  temperate  in  tone  and  waging  no  warfare  on  the  labor 
organization  as  such,  nevertheless  maintain  certain  fundamental 
principles  which  are  directly  in  conflict  with  the  fundamental 
tenets  of  trade  unionism.  These  associations,  for  instance, 
maintain  that  the  method  of  wage  payment  —  i.e.  whether 
wages  shall  be  reckoned  by  the  hour,  the  piece,  or  the  premium 
system  —  is  a  matter  which  concerns  the  employer  alone,  and 
they  refuse  to  submit  such  questions  to  collective  bargaining  or 
arbitration.  Associations  in  this  second  group  do  not  needlessly 
foment  strifes  with  the  unions,  but  they  regard  industrial  peace 
as  a  consideration  secondary  to  the  maintenance  of  their  funda- 
mental principles,  and  accordingly  they  have  been  involved  in  a 
number  of  protracted  strikes  and  disputes.  Finally,  there  is  a 
third  group  of  employers'  associations,  of  which  the  average  citi- 
zens' alliance  is  a  good  example,  which  may  be  correctly  described 
as  "  union  smashers."  Such  associations  have  little  regard  for 
the  establishment  of  sound  principles  of  collective  bargaining, 
and  they  are  usually  violently  opposed  to  any  recognition  of 
organized  labor ;  their  aim  is  to  weaken  and  harass  their  enemy, 
the  labor  organization,  whenever  possible.  They  represent 
among  employers  something  of  the  same  feeling  and  attitude 
which  characterize  the  Industrial  Workers  of  the  World  (a  syn- 
dicalist organization  opposed  to  trade  agreements,  trade  union- 
ism, and  even  to  socialism ;  placing  its  reliance  upon  the  strike, 
direct  action,  and  sabotage).  The  extremely  radical  organiza- 
tions on  both  sides  secure,  by  reason  of  their  revolutionary  ut- 
terances and  tactics,  far  more  attention  than  their  intrinsic 
importance  justifies. 

Owing  to  this  difference  of  policy  among  the  various  employers' 
associations,  it  is  difficult  to  predict  how  the  anti-labor  move- 
ment will  affect  that  question  in  which  the  public  interest  is 


LABOR   PROBLEMS  457 

greatest  —  the  question  of  industrial  peace.  For  some  little 
time,  perhaps,  the  militant  enthusiasm  of  the  more  belligerent 
associations  will  probably  result  in  multiplying  strikes  and 
lockouts.  In  the  end,  however,  they  will  probably  contribute 
effectively  to  the  maintenance  of  industrial  peace  by  checking 
the  more  extortionate  demands  of  the  unions  and  by  securing 
that  degree  of  organization  among  employers  which  is  necessary 
for  the  successful  operation  of  collective  bargaining.  If  wage 
earners  are  to  act  in  concert  by  common  or  standard  rules,  it  is 
evident  that  eventually  they  will  have  to  deal  with  an  organized 
body  of  employers;  and  the  sooner  such  organization  of  em- 
ployers is  perfected,  the  sooner  will  collective  bargaining  be 
established  as  the  regular  method  of  determining  conditions  of 
employment. 

The  Agencies  of  Industrial  Peace.  —  Although  collective  bar- 
gaining does  not  necessarily  and  in  every  instance  operate  to 
discourage  strikes,  its  net  influence  is  unquestionably  favorable 
to  the  maintenance  of  industrial  peace.  Where  a  powerful  trade 
union  exists,  and  the  employers  resolutely  refuse  to  deal  with  it, 
strikes  are  frequent.  Where  the  opposite  policy  is  pursued,  and 
the  employers  frankly  recognize  the  union,  strikes  are  infrequent. 
In  the  bituminous  mining  industry  of  the  East,  among  steam 
railway  employees  in  the  train  service,  in  the  needle  trades  of 
New  York,  and  in  many  of  the  industries  of  England,  strong 
organizations  of  employers  and  employees  have  shown  through 
collective  bargaining  the  power  to  maintain  industrial  peace  for 
long  periods  of  time. 

Trade  Arbitration.  —  In  England,  many,  if  not  most,  of  the 
wider  systems  of  collective  bargaining  are  based  upon  formal 
treaties,  which  provide  for  arbitration  in  case  the  two  parties 
cannot  come  to  an  agreement  concerning  terms.  This  is  fre- 
quently referred  to  as  trade  arbitration.  But  in  the  United  States 
many  of  the  general  conferences  are  based  upon  agreements 
which  do  not  provide  for  arbitration  at  all.  Peace  is  main- 
tained, although  neither  side  promises  in  any  way  to  refrain 
from  strikes  or  lockouts.  Mutual  respect  and  free  discussion 
prevent  actual  warfare.     Indeed,  many  authorities  upon  this 


458  OUTLINES  Ol    ECONOMICS 

subject  are  inclined  to  think  that  the  introduction  of  arbitration, 
even  as  a  last  resort,  weakens  the  efficiency  of  collective  bargain- 
ing- It  is  almost  always  necessary  for  both  sides  in  collective 
bargaining  to  make  some  compromises;  and  this  necessity 
imposes  upon  the  representatives  of  the  trade  unions  the  dis- 
agreeable duty  of  reporting  to  their  constituents  that  they  have 
not  secured  the  exact  terms  which  they  were  instructed  in  the 
beginning  to  demand.  Because  of  this  fact,  if  a  provision  for 
arbitration  exists,  the  union  representatives  are  disposed  to  throw 
the  responsibility  of  disappointing  their  followers  upon  the 
shoulders  of  the  arbitrators. 

Moreover,  collective  bargaining  is  essentially  inconsistent 
with  arbitration.  Collective  bargaining  is  commercial  and 
elastic ;  it  deals  with  the  formulation  of  future  terms  of  employ- 
ment ;  it  looks  to  securing  the  best  results  possible ;  it  has  no 
rational  foundation  save  the  willingness  of  the  parties  concerned 
to  get  the  most  possible  for  their  labor  or  their'  money,  as  the 
case  may  be ;  whereas  arbitration  is  judicial  in  essence,  and  its 
successful  application  implies  the  acceptance  of  some  established 
principle  of  wage  adjustment,  in  the  justice  of  which  both  parties 
acquiesce.  It  is  unfortunate  but  true  that  up  to  the  present 
time  no  one  has  ever  formulated  a  doctrine  of  wage  adjustment 
which  is  at  once  workable  and  acceptable  to  a  majority  of  the 
people.  Arbitration  is  a  perfectly  logical  device,  and  works 
successfully  in  the  interpretation  of  minor  difficulties  growing 
out  of  a  broad  agreement  which  has  already  been  accepted. 
Or,  if  both  sides  adopt  some  governing  principle,  it  is  perfectly 
possible  for  a  disinterested  arbitrator  to  decide  what  this  principle 
demands  in  a  given  situation.  But  as  a  helpful  device  in  securing 
the  initial  adoption  of  a  fundamental  agreement,  mediation  is 
superior  to  trade  arbitration,  although  the  latter  appeals  to  the 
employers  because  it  promises  to  prevent  stoppage  of  work 
pending  the  decision  of  disputes. 

Voluntary  Arbitration.  — There  are,  of  course,  many  other 
kinds  of  arbitration  which  have  proved  helpful  in  maintaining 
the  industrial  peace.  Most  advanced  states  now  maintain 
boards  of  conciliation  and  arbitration,  whose  business  it  is  to 


LABOR   PROBLEMS  459 

prevent  strikes  if  possible,  and  to  adjust  or  settle  them  after 
they  occur.  For  the  most  part,  these  voluntary  boards  of  con- 
ciliation and  arbitration  have  shown  little  ability  to  cope  with  the 
real  situation.  Much  more,  however,  could  be  made  of  voluntary 
conciliation  and  arbitration  than  has  been  made  in  the  past. 
The  short  but  very  promising  history  of  the  Canadian  Industrial 
Disputes  Investigation  Act  of  1907  suggests  that  a  law  which, 
like  the  Canadian  Act,  forbade  strikes  and  lockouts  in  important 
industries  until  an  impartial  board  of  conciliators  had  had  time 
to  investigate  the  dispute  and  publish  their  recommendations 
and  findings  concerning  the  equities  of  the  case,  would  go 
far  toward  delivering  us  from  the  more  injurious  industrial 
conflicts.  The  vital  provisions  of  such  a  method  of  concilia- 
tion are :  (1)  the  prohibition  of  strikes  and  lockouts  before 
and  during  the  investigation ;  (2)  widespread  publication  of 
the  findings  of  the  board  of  investigation  and  conciliation ;  and 
(3)  full  permission  to  strike  or  lockout  after  the  publication  of 
the  findings. 

Compulsory  Arbitration.  —  In  New  Zealand  an  even  more 
radical  remedy  —  "  compulsory  arbitration  "  —  has  been  tried. 
Seven  workingmen  in  any  industry  may  organize  a  union  and 
lodge  a  demand  for  better  conditions  of  employment  before 
arbitration  boards,  whose  decisions,  when  ratified  by  the  supreme 
or  central  court  of  arbitration,  are  absolute  and  binding.  Simi- 
larly, any  employer  whose  workmen  are  organized  in  a  union  may 
take  a  case  to  the  arbitration  tribunals  for  settlement.  An 
award  of  the  central  court  of  arbitration  may  be  extended  by 
the  court  to  all  competitors  of  the  original  employer  in  the  colony. 
In  this  way,  compulsory  arbitration  brings  about  the  intro- 
duction of  minimum  wages  and  other  conditions  of  employment, 
established  by  the  authority  of  the  state  and  enforced,  not  only 
by  the  watchful  eyes  of  the  parties  concerned,  but  by  the  factory 
inspectors  themselves.  In  Victoria  and  South  Australia  much 
the  same  results  are  reached  through  the  agency  of  wage  boards 
—  containing  representatives  of  both  the  employers  and  their 
employees,  with  a  chairman  selected  by  these  representatives 
or  appointed  by  the  government  —  which  are  empowered  to  pre- 


460  OUTLINES  OF  ECONOMICS 

scribe  minimum  wages  and  other  conditions  of  employment,  that 
are  enforced,  as  in  New  Zealand,  by  the  factory  inspectors. 
Strikes,  however,  are  not  prohibited  under  this  system,  although 
they  are  very  rare  in  industries  in  which  wage  boards  regulate 
wages  and  hours  of  labor. 

It  is  impossible  to  enter  into  a  detailed  discussion  of  either  the 
New  Zealand  or  the  Victoria  system  at  this  place.  Both  systems 
have  been  in  operation  since  1896,  both  have  been  extended  to 
other  Australian  colonies.  The  laws  recently  adopted  in  New 
South  Wales,  South  Australia,  and  Queensland  contain  the 
principal  features  of  both  systems.  The  fixing  of  minimum 
conditions  of  employment  is  perhaps  the  most  important  element 
in  both  systems,  but  it  is  noteworthy  that  the  compulsory 
arbitration  idea  has  endured  and  spread.  Strikes  are  not  wholly 
prevented,  particularly  in  industries  in  which  the  labor  organiza- 
tions are  very  strong ;  and  many  employers  criticize  both  systems 
vehemently.  With  the  passage  of  time,  however,  they  have 
been  strengthened,  not  repealed ;  and  the  consensus  of  qualified 
opinion  seems  to  be  that  they  have  succeeded.  But  there  is 
little  probability  that  general  compulsory  arbitration  will  be 
introduced  into  this  country  in  the  near  future.  It  would  in  all 
probability  be  held  to  conflict  with  state  and  federal  constitu- 
tions, and,  moreover,  a  large  majority  of  trade  unionists  are 
opposed  to  it. 

The  Ultimate  Solution.  —  In  arriving  at  a  decision  concerning 
the  measures  which  ought  to  be  taken  to  maintain  industrial 
peace,  it  should  be  remembered  that  strikes  are  much  more 
destructive  and  dangerous  in  some  industries  than  in  others,  and 
that  here,  as  in  most  other  economic  problems,  it  is  dangerous  to 
proceed  wholly  on  the  basis  of  general  principles.  In  most 
industries,  in  our  opinion,  the  strike  question  may  safely  be  left 
to  the  enlightened  self-interest  of  the  parties  concerned,  trusting 
to  collective  bargaining  and  the  work  of  voluntary  arbitration  to 
prevent  an  excessive  amount  of  war.  In  small  competitive 
industries  the  peaceful  strike  is  not  necessarily  an  alarming 
phenomenon. 

Slowly  and  surely,  however,  the  opinion  is  gathering  force  that 


LABOR   PROBLEMS  461 

in  those  industries  which  vitally  touch  the  public  welfare  (such  as 
the  anthracite  coal  industry,  railway  transportation,  and  the  like) 
the  public  should,  and  by  an  exercise  of  legal  ingenuity  might,  find 
means  to  preserve  the  peace  whether  the  two  parties  immediately 
concerned  desire  peace  or  not.  Compulsory  arbitration  in  com- 
petitive industries  would  unquestionably  be  unconstitutional  in 
this  country.  But  with  quasi-public  industries,  "  industries 
affected  by  a  public  interest,"  the  question  is  entirely  different. 
If,  because  of  their  monopolistic  character  and  their  intimate 
connection  with  the  convenience  of  the  public,  the  legislature 
may  regulate  the  service  and  the  rates  of  such  industries,  it 
would  seem  to  follow  even  more  clearly  that  the  legislature  may 
adopt  any  measure  necessary  to  prevent  the  utter  cessation  01 
such  industries  by  strikes  and  lockouts.  If,  for  instance,  the 
fare  charged  by  a  street  railway  may  be  regulated  by  the  state, 
in  order  to  prevent  monopolistic  extortion,  how  much  more 
justifiable  would  be  the  action  of  the  state  in  preventing  the 
complete  interruption  of  the  traffic  of  the  railway  by  means  of  a 
strike  or  lockout !  The  federal  government  in  the  Erdman 
and  Newlands  Acts  provides  machinery  for  mediation  and 
arbitration  in  disputes  affecting  interstate  railways.  Many 
important  disputes  which  threatened  widely  to  interrupt  inter- 
state commerce  have  been  settled  by  mediation  —  and  a  few 
very  important  disputes  by  arbitration  —  under  these  laws. 
Many  threatened  strikes  by  employees  in  the  train  service  have 
been  prevented ;  and  it  is  interesting  to  observe  that  with  the 
passage  of  time  more  use  is  made  of  arbitration,  and  that  under 
certain  circumstances  the  arbitrators  are  permitted  to  make 
binding  awards.  Compulsory  arbitration  or  public  regulation 
of  wages  in  the  railway  and  other  industries  affected  with  a 
public  use  is,  we  believe,  an  inevitable  concomitant  of  the 
public  regulation  of  prices  and  profits  in  these  fields. 

Profit  Sharing.  —  Profit  sharing  attempts,  not  to  provide  a 
remedy  for  industrial  disputes,  but  to  anticipate  and  prevent 
them  by  assigning  to  the  employees  a  share  of  the  profits  fixed 
in  advance.  It  is  held  that  this  arrangement  enlists  the  em- 
ployees' interest  in  the  success  of  the  business,  makes  them  more 


402  OUTLINES  OF  ECONOMICS 

economical,  and  so  increases  their  zeal  and  efficiency  that  the 
share  of  profits  which  they  receive  does  not  reduce  in  the  long 
run  the  earnings  of  the  employer.  In  other  words,  the  em- 
ployees create  the  fund  from  which  their  bonus  is  paid.  This 
bonus  may  be  paid  in  many  different  ways :  either  in  cash  at  the 
end  of  the  business  year,  or  in  shares  of  stock  in  the  company  in 
question,  thus  making  the  workman  partial  owner  of  the  busi- 
ness ;  or  it  may  be  amassed  in  a  savings  or  insurance  fund,  from 
which  in  his  old  age  the  workman  receives  a  pension,  or  his 
family  an  annuity  or  cash  premium  at  the  time  of  his  death.  The 
last  method  of  profit  sharing  is  usually  spoken  of  as  "  deferred 
participation." 

Neither  historical  study  nor  theoretical  analysis  of  profit  shar- 
ing furnishes  reasonable  ground  for  the  belief  that  this  method  of 
industrial  remuneration  will  ever  play  an  important  part  in 
solving  the  modern  labor  problem.  Informal  profit  sharing  is 
probably  very  old ;  and  the  principle  or  theory  was  recognized 
by  the  French  economist  and  statesman,  Turgot,  as  early  as 
1775.  In  1842  the  celebrated  French  firm  of  Leclaire  inau- 
gurated a  system  of  profit  sharing  which  has  been  permanently 
successful.  In  the  third  quarter  of  the  nineteenth  century 
profit  sharing  was  widely  discussed.  In  1878  a  hundred  and 
twenty  instances  were  known,  and  the  number  grew  steadily 
until  about  1896,  since  which  time  the  relative  importance  of 
profit  sharing  as  a  method  of  industrial  remuneration  seems  to 
have  declined,  notwithstanding  the  wide  publicity  which  has 
been  given  to  the  profit-sharing  plans  of  the  United  States  Steel 
Corporation  and  the  Ford  Motor  Company. 

The  reasons  why  profit  sharing  has  not  proved  more  successful 
are  various.  In  the  first  place,  it  has  incurred  the  enmity  of 
most  labor  leaders,  who  oppose  it  because  it  has  often  been 
introduced  after  a  disastrous  strike  as  an  antidote  to  trade 
unionism,  and  because  they  believe  that  it  stimulates  the  men 
to  work  beyond  their  strength,  and  eventually  results  —  as 
overspeeding  always  results  —  in  reduced  wages. 

In  the  second  place,  it  is  illogical  and  inconsistent  as  explained 
by  most  of  its  advocates.     The  latter  assert  that  the  workmen 


LABOR   PROBLEMS  463 

create  the  fund  from  which  their  dividends  are  paid  by  increased 
care,  zeal,  and  speed.  If  this  be  true,  and  the  system  can  hardly 
prove  a  permanent  success  unless  it  is  true,  the  end  which  profit 
sharing  seeks  would  be  better  achieved  by  the  piece  rate  or  gain 
sharing  methods  of  wage  payment.  By  both  of  these  methods 
the  worker  gets  his  premium  for  extra  zeal  and  efficiency  as  part 
of  his  wage,  not  as  a  gift ;  gets  it  on  pay  day,  not  at  the  end  of  the 
year ;  and  feels  as  free  to  bargain  and  higgle  about  the  size  of  the 
premium  as  he  does  about  the  size  of  the  wage.  Moreover,  his 
premium  cannot  be  dissipated  by  unwise  management  or  dishon- 
esty on  the  part  of  the  employer,  and  it  cannot  be  lost  by  reason 
of  his  death,  discharge,  or  change  of  employment. 

Profit  sharing  is  too  often  applied  in  an  unbusinesslike  way 
that  smacks  of  philanthropy.  The  average  employer  con- 
sciously or  unconsciously  expects  something  in  return  for  the 
dividends  which  he  distributes.  And  if  he  does  expect  a  return, 
it  is  far  better  that  he  should  pay  for  it  by  a  method  which  is 
certain,  fixed  by  contract  or  bargain  in  advance,  and  paid,  not  at 
long  intervals,  during  which  it  is  threatened  by  the  varying 
fortunes  of  the  business,  but  at  the  end  of  the  week  or  month 
when  ordinary  wages  are  paid.  Of  course,  if  in  addition  to  fair 
wages  the  employer  wishes  to  distribute  a  gratuitous  dividend 
at  the  end  of  the  year,  for  which  he  expects  nothing  in  return,  the 
employee  is  not  likely  to  object,  and  the  generosity  of  the  em- 
ployer will  probably  do  no  harm.  But  such  a  system  of  profit 
sharing  cannot  be  expected  to  become  prevalent  throughout  a 
competitive  commercial  system  in  which  most  employers  cannot 
be  philanthropists,  even  if  they  desire.  Moreover,  human  na- 
ture is  so  constituted  that  gifts  of  this  kind  create  in  the  mind 
of  the  giver  an  inevitable  expectation  of  recompense. 

Industrial  Democracy.  —  The  industrial  organization  of  the 
past  was  despotic.  The  despotic  principle,  the  one-man  power, 
is  an  excellent  thing  in  its  own  time  and  place.  It  gives  to  indus- 
try the  elasticity,  celerity,  and  general  efficiency  which  come 
from  singleness  of  aim ;  and  in  industry,  despotism  has  con- 
tinued longer  than  in  the  political  sphere.  But  it  is  merely  a 
phase  of  development  and  cannot  be  regarded  as  final.     Else- 


464  OUTLINES  OF   ECONOMICS 

where  the  despotic  principle  has  been  softened  or  limited,  —  in 
politics,  in  religion,  in  the  family,  —  and  eventually  this  dis- 
cordant element  is  bound  to  disappear  or  undergo  serious  modi- 
fication in  industry.  The  labor  movement  is  primarily  a 
concerted  effort  to  achieve  industrial  democracy,  which  means  self- 
rule,  self-control,  the  self-direction  of  the  masses  in  their  efforts 
to  gain  a  livelihood.  It  is  principally  because  profit  sharing 
means  a  departure  from,  and  not  an  approach  toward,  industrial 
democracy  that  it  has  made  so  little  progress,  comparatively 
speaking,  in  the  last  fifty  years.  A  far  more  consistent  method 
of  securing  self-government  is  found  in  cooperation. 

Cooperation  is  of  two  kinds,  coercive  and  voluntary.  Coer- 
cive cooperation,  which  implies  a  partial  or  complete  application 
of  socialism,  is  discussed  in  another  chapter. 

Voluntary  cooperation  takes  many  different  forms,  among 
which  we  may  distinguish :  (1)  distributive  or  consumers'  coop- 
eration, sometimes  spoken  of  as  cooperative  buying ;  (2)  coopera- 
tive borrowing  or  cooperative  credit ;  (3)  cooperative  marketing ; 
and  (4)  producers'  or  pure  cooperation. 

Consumers'  or  distributive  cooperation  has  no  necessary  con- 
nection with  the  transportation  of  goods,  but  refers  merely  to  a 
method  of  retail  or  wholesale  exchange.  Purchasers  of  groceries, 
dry  goods,  and  the  like  come  together  to  purchase  what  they 
need,  and  thus  eliminate  profits.  They  form  a  stock  company, 
subscribe  for  shares,  employ  a  manager  and  clerks,  —  who  often 
do  not  even  share  in  the  profits,  —  and  start  a  business.  Divi- 
dends are  sometimes  paid  only  on  shares,  but  the  approved  way 
is  to  pay  a  moderate  interest  on  the  investment  and  to  dividei 
profits  among  the  customers  in  proportion  to  purchases,  the  divi- 
sion being  made  at  the  end  of  stated  intervals.  Usually  a  larger 
dividend  is  distributed  to  shareholders  than  to  ordinary  cus- 
tomers ;  and  in  some  cases  the  employees  receive  as  large  a  bonus 
as  the  shareholders.  Profits  are  thus  said  to  be  divided  among 
capital,  custom,  and  labor.  But  so  far  as  labor  is  concerned,  the 
most  that  can  be  said  is  that  it  receives  a  small  share  of  the 
earnings ;  labor  does  not  cooperate  in  the  sense  that  it  has  an 
important  voice  in  the  management  of  the  business.  The  scheme 


LABOR  PROBLEMS  465 

is  one  of  distributive  cooperation  plus  profit  sharing,  not  one  of 
pure  cooperation. 

Cooperative  credit  and  cooperative  marketing  are  familiar 
phenomena  in  the  United  States :  the  first  in  the  form  of  the 
well-known  building  and  loan  association ;  the  second  in  the 
form  of  fruit  growers'  associations,  cooperative  elevator  com- 
panies, and  the  like,  formed  for  the  purpose  of  securing  better 
terms  and  facilities  from  railroads,  commission  houses,  and 
middlemen  in  general.  In  191 2,  for  instance,  there  were  6300 
building  and  loan  associations  in  the  United  States,  with  a 
membership  of  2,500,000  and  total  assets  of  $1,138,000,000. 
At  the  same  time  there  were  many  cooperative  telephone  com- 
panies, particularly  in  small  towns  and  rural  districts. 

The  good  which  these  cooperative  associations  have  accom- 
plished is  enormous,  and  there  can  be  no  doubt  of  their  practi- 
cability. They  have  not  only  proved  commercially  profitable  to 
the  participators,  but  they  have  trained  them  to  '"  team  work  " 
and  inculcated  the  spirit  of  mutual  concession,  the  give  and  take 
of  concerted  endeavor,  which  makes  for  social  solidarity  and  con- 
stitutes such  an  indispensable  element  of  good  citizenship  in  a 
democratic  state. 

But  they  have  done  little  and  promise  to  do  little  in  solving 
the  labor  problem  or  in  essentially  improving  the  distribution  of 
wealth.  They  are,  for  the  most  part,  composed  of  small  capital- 
ists, farmers,  or  salaried  men  (not  wage  earners),  and  in  organiza- 
tion differ  little  from  democratically  managed  stock  companies 
of  the  usual  type.  Many,  if  not  most,  of  the  marketing  associa- 
tions are  profit-making  concerns  whose  employees  have  no  more 
voice  in  the  selection  of  their  bosses,  and  no  more  share  in  the 
management  of  the  business,  than  the  employees  of  an  ordinary 
corporation.  Even  in  the  British  cooperative  societies  the 
employees  have  no  share  in  the  management,  and  though  some  of 
the  associations  —  notably  the  Scottish  Wholesale  Society  — 
indulge  in  a  mild  species  of  profit  sharing  with  their  employees, 
the  result  is  not  industrial  democracy,  not  self-government,  but 
merely  joint  buying  plus  a  paternalistic  scheme  of  profit  sharing. 
The  limits  of  the  success  of  the  British  cooperative  movement 


466  OUTLINES   OF  ECONOMICS 

are  suggested  by  the  fact  that  the  employees  of  the  cooperative 
societies  have  formed  themselves  into  a  trade  union  for  the 
betterment  of  their  condition  of  employment.1 

While  consumers'  cooperation  and  cooperative  marketing  — 
both  designed  to  abolish  the  profits  of  the  middleman  —  are 
important  and  praiseworthy  forms  of  economic  association,  they 
have  little  effect  upon  the  wage-earning  classes,  and  offer  no 
remedy  for  the  antagonism  between  capital  and  labor  in  manu- 
facturing industries.  The  variety  of  cooperation  which  really 
copes  with  these  questions  and  seriously  attempts  to  regenerate 
the  wage  system  is  producers'  cooperation.  The  essential  fea- 
tures of  this  form  of  cooperation  are  (i)  that  each  group  of 
workers  is  to  be  associated  by  their  own  free  choice ;  (2)  that 
these  associates  shall  work  under  a  leader  elected  and  removable 
by  themselves ;  and  (3)  that  the  collective  remuneration  of  the 
labor  performed  by  the  group  shall  be  divided  among  all  its 
members  (including  the  leader)  in  such  a  manner  as  shall  be 
arranged,  upon  principles  recognized  as  equitable  by  the  society 
themselves.2 

Successful  cooperative  experiments  fulfilling  the  above  con- 
ditions are  seldom  met  with.  But  they  are  not  unknown.  Here 
and  there  a  man  of  transcendent  commercial  genius  and  extraor- 
dinary sympathy  has  succeeded  in  democratizing  his  business, 
turning  it  over  to  his  employees,  and  so  impressing  his  spirit  and 
his  methods  upon  his  successors  that  the  business  continues  to 
prosper  under  the  regime  of  self-government.  An  illustration 
is  found  in  the  Godin  Familistere  of  Guise,  France,  which,  begin- 
ning with  a  scheme  of  profit  sharing  in  1877,  has  finally  resulted 
in  the  establishment  not  only  of  a  cooperative  manufacturing 
enterprise,  but  in  the  successful  conduct  of  what  practically 
amounts  to  a  cooperative  community. 

But  such  cases  are  rare.  Most  experiments  in  producers'  co- 
operation have  failed,  and  we  fear  they  must  continue  to  fail. 
They  apparently  cannot  meet  the  competition  of  businesses 

1  For  an  account  of  some  of  the  advantages  of  certain  types  of  cooperative 
marketing,  see  Chap,  xxix  {Agricultural  Problems). 

*D.  F.  Schloss,  Methods  of  Industrial  Remuneration,  p.  22J1 


LABOR  PROBLEMS  467 

organized  in  the  ordinary  way,  directed  by  one  man  or  set  of  men 
with  all  the  efficiency,  mobility,  and  adaptability  that  come  from 
singleness  of  aim  and  undivided  management.  Industrial 
democracy,  as  achieved  in  the  cooperative  form  of  industrial 
organization,  is  too  unwieldy,  too  slow,  too  mechanical.  Multi- 
tudinous management  means  relatively  uncertain,  indecisive,  and 
inefficient  management. 

A  modified  form  of  producers'  cooperation  is  not  unknown  among  the 
manufacturing  industries  of  this  country.  An  approximate  idea  of  the 
extent  of  this  form  of  industrial  organization  may  be  gathered  from  recent 
census  statistics.  In  1909  the  statistics  of  manufactures  relating  to  char- 
acter of  ownership  show  a  separate  class  of  "miscellaneous  business  organiza- 
tions" which  consists  almost  entirely  of  cooperative  manufacturing  concerns. 
There  were  in  this  group  4120  establishments  (constituting  1.5  per  cent  of 
all  manufacturing  establishments)  employing  12,934  persons  (0.2  per  cent 
of  all  wage  earners),  producing  goods  with  an  annual  value  of  $104,766,104 
(0.5  per  cent  of  the  aggregate  product).  Most  of  these  associations  are 
cooperative  creameries;  and  it  is  interesting  to  note  that  in  this  great 
industry  —  which  was  cooperative  in  origin  —  the  corporate  form  of  organ- 
ization increases  in  importance,  measured  by  value  of  products,  more  rapidly 
than  the  cooperative  form.  These  figures  furnish  a  maximum  estimate  of 
producers'  cooperation  in  the  United  States,  and  a  large  majority  of  the 
concerns  credited  to  cooperation  in  this  enumeration  would  fail  to  satisfy 
a  strict  definition  of  producers'  cooperation. 

The  wage  contract,  whatever  its  defects,  has  one  striking  virtue 
—  certainty.  The  wage  earner  knows  what  to  expect  and  gets 
what  he  expects.  He  is  safeguarded  in  large  measure  against 
business  risk,  and  although  he  may  pay  too  high  a  price  for  his 
safety,  the  safety  itself  is  a  highly  desirable  thing.  It  is  one  of 
the  weaknesses  of  producers'  cooperation  that  the  workman  is 
encouraged  to  invest  his  savings  in  the  hazardous  competitive 
experiments  in  which  he  is  engaged.  He  becomes  part  owner 
of  the  enterprise,  to  be  sure,  but  by  doing  so  he  assumes  the  risk 
of  failure,  a  risk  which,  other  things  being  equal,  it  is  desirable 
to  eliminate.  It  is  very  likely  that  the  ultimate  method  by 
which  industrial  democracy  is  achieved  will  retain  that  feature 
of  the  present  wage  system  by  which  most  of  the  workers  aiv 
largely  safeguarded  against  business  losses. 


468  OUTLINES  OF  ECONOMICS 

The  Future  of  the  Union.  —  If  industrial  democracy  is  to  be 
achieved,  all  present  indications  are  that  it  will  be  through  the 
labor  organization.  Since  the  introduction  of  collective  bar- 
gaining, its  range  has  constantly  widened.  Beginning  with 
questions  of  wages,  hours  of  labor,  and  apprenticeship,  it  has 
gradually  spread,  until  at  the  present  time  some  unions  bargain 
about  the  sanitary  conditions  of  the  work,  the  introduction  of 
safety  devices,  the  employment  of  women,  the  use  of  machinery, 
and  the  status  of  the  men  with  whom  their  members  work.  A 
few  powerful  unions  insist  that  the  foremen  under  whom  their 
members  work  shall  belong  to  the  union,  demand  a  voice  in  the 
discharge  of  employees,  and  try  to  force  the  employer,  when 
taking  on  new  men,  to  select  them  in  order  from  lists  of  unem- 
ployed journeymen  prepared  by  the  union.  These  demands,  or 
course,  may  be  harmful :  in  industry  as  in  government,  certain 
functions  must  be  entrusted  almost  wholly  to  the  executive  head. 
The  fact  that  power  may  be  abused,  however,  is  really  beside 
the  point.  The  point  lies  in  the  possibility  of  extending  the 
range  of  collective  bargaining  until  the  employees  shall  have  a 
voice  —  and  it  is  to  be  hoped  a  prevailing  voice  —  in  determining 
the  conditions  of  employment.  Through  collective  bargaining 
the  control  of  the  employees  over  the  business  may  be  indefi- 
nitely expanded.  Once  having  secured  control,  the  majority 
may  learn,  as  they  are  slowly  learning  in  political  life,  to  leave 
certain  particularly  difficult  questions  to  their  industrial  cap- 
tains. In  the  past,  labor  has  had  to  seek  capital  and  serve  it. 
In  the  future,  capital  may  have  to  seek  and  serve  labor. 

These  words  are  written  in  no  spirit  of  advocacy,  and  with  no 
intention  of  palliating  the  obvious  shortcomings  of  the  trade 
union.  But  the  fact  remains  —  whether  we  like  it  or  not  —  that 
economic  theory  and  economic  history  unite  in  the  conclusion 
that  the  union  has  come  to  stay  as  long  as  the  system  of  capi- 
talistic production.  The  union  must  be  improved,  it  cannot  be 
extirpated ;  and  the  most  urgent  task  of  the  present  is  to  con- 
vince employers  and  unionists  that  there  will  be  no  real  peace 
until  employers  acknowledge  the  inevitableness  of  the  union, 
ind  unions  acknowledge  —  sympathetically  and  in  practical 


LABOR   PROBLEMS  469 

Arays  —  the  social  serviceableness  of  the  employer.  Trade 
unions  have  been  guilty  of  many  sins  —  violence,  monopoly, 
political  corruption.  But  their  gravest  danger  at  the  present 
time  is  a  false  philosophy,  in  accordance  with  which  many 
unionists  have  come  to  believe  that  the  best  way  to  help  the 
union  is  to  oppose  the  employer.  This  is  not  true  of  the  more 
wisely  conducted  unions.  The  railway  brotherhoods  frequently 
unite  with  the  railway  managers  in  securing  legislation  favorable 
to  the  railway  industry ;  and  the  history  of  the  National  Civic 
Federation,  for  example,  proves  that  a  number  of  the  opposing 
leaders  are  keenly  aware  that  capital  and  labor  have  interests 
in  common  as  well  as  in  opposition.  In  some  way,  however, 
united  labor  as  a  whole  must  learn  how  to  drive  just  as  favorable 
a  bargain  as  possible  with  the  employers  in  the  first  instance,  and 
then,  the  bargain  having  been  made,  to  bend  every  effort  in  loyal 
cooperation  with  the  employer  to  make  the  business  the  greatest 
possible  success.  This  is  not  mere  platitude.  In  the  long  run, 
the  institution  that  stands  in  the  way  of  productive  efficiency 
will  perish.  The  trade  union  must  bring  into  industry  something 
besides  conflict,  or  it  will  disappear.  The  union  that  so  con- 
ducts itself  as  to  make  the  non-union  man  or  the  non-union  shop 
more  efficient  than  the  union  man  or  the  union  shop,  simply  puts, 
a  premium  upon  the  suppression  of  unionism. 


QUESTIONS 

1.  Is  the  industrial  or  the  trade  union  the  more  logical  form  of  organiza- 
tion? Can  the  two  be  reconciled  ?  Mention  as  many  kinds  of  jurisdiction 
disputes  as  you  can. 

2.  Does  the  trade  union  rest  upon  a  sound  economic  basis?  Is  it  likely 
to  endure?  Is  it  in  any  large  degree  responsible  for  the  conflict  between 
labor  and  capital? 

3.  Are  all  attempts  to  achieve  a  monopoly  illegitimate?  Is  there  more 
justification  for  labor  monopolies  than  industrial  monopolies? 

4.  Is  the  policy  of  the  closed  shop  ever  justifiable?  Intimidation  of 
non-union  men?  restriction  of  apprenticeship?   regulation  of  output? 

5.  The  strike  has  been  defined  as  a  "concerted  cessation  of  work";  is 
this  definition  correct?  Have  men  a  " right"  to  strike  whenever  they  wish? 
Are  employers  justified  in  "locking  out"  their  men  at  pleasure? 


470  OUTLINES  OF  ECONOMICS 

6.  Is  the  "blacklist"  more  justifiable  than  the  boycott?  Can  either  the 
"  blacklist"  or  the  boycott  be  conducted  in  a  lawful  manner? 

7.  Distinguish  between  trade  arbitration,  voluntary  arbitration,  com- 
pulsory investigation,  and  compulsory  arbitration.  What  are  the  defects 
of  arbitration  as  a  method  of  settling  labor  disputes? 

8.  What  is  the  difference  between  the  Victorian  (wage-board)  and  the 
New  Zealand  (compulsory  arbitration)  systems? 

9.  Why  do  labor  leaders  oppose  compulsory  arbitration?  Is  their  op- 
position a  sufficient  reason  for  rejecting  it?  Why  is  the  plea  for  compulsory 
arbitration  particularly  strong  in  the  case  of  monopolistic  industries? 

10.  How  does  "gain  sharing"  differ  from  "profit  sharing"?  Is  profit 
sharing  necessarily  paternalistic  ?     If  so,  is  this  a  defect  ? 

11.  Does  consumers'  cooperation  materially  advance  industrial  democ- 
racy?    Is  producers'  cooperation  likely  to  grow  and  expand? 


REFERENCES 

Adams,  T.  S.,  and  Sumner,  H.  L.    Labor  Problems. 

Brooks,  J.  G.     The  Social  Unrest. 

Carlton,  F.  T.     The  History  and  Problems  of  Organized  Labor. 

Cole,  G.  D.  H.     The  World  of  Labor. 

Commons,  J.  R.  Trade  Unionism  and  Labor  Problems  and  Labor  and 
Administration. 

Commons,  J.  R.  (Editor).  Documentary  History  of  American  Industrial 
Society  (10  vols.). 

Ely,  R.  T.     The  Labor  Movement  in  America. 

Gilman,  N.  P.     Methods  of  Industrial  Peace;  A  Dividend  to  Labor. 

Hollander,  J.  H.  and  Barnett,  G.  E.  (editors).  Studies  in  American  Trade 
Unionism. 

Industrial  Commission.     Report,  Vols,  xvii,  xix. 

Laddler,  H.  W.     Boycotts  and  the  Labor  Struggle. 

Le  Rossignol,  J.  E.,  and  Stewart,  W.  D.  State  Socialism  in  New  Zealand, 
Chaps,  xiii,  xiv. 

Levasseur,  E.     The  American  Workman. 

Marot,  Helen.     American  Labor  Unions. 

Mitchell,  John.    Organized  Labor. 

Pigou,  A.  C.     Principles  and  Methods  of  Industrial  Peace. 

Rowntree,  B.  S.     Poverty:   A  Study  of  Town  Life. 

Schloss,  D.  F.     Methods  of  Industrial  Remuneration. 

Webb,  Catherine.     Industrial  Cooperation. 

Webb,  Sidney  and  Beatrice.  History  of  Trade  Unionism;  1 ndusli id- 
Democracy. 


CHAPTER  XXIII 

LABOR  LEGISLATION 

The  conditions  of  employment  may  be  fixed  by  individual 
bargaining  between  the  employer  and  employee,  by  collective 
bargaining  between  the  employer  and  groups  of  employees,  or 
by  the  State  itself  through  legislative  enactment.  The  last 
method  has  in  recent  years  been  used  not  only  with  increasing 
frequency,  but  for  a  variety  of  purposes  which  it  is  desirable  to 
differentiate.  In  the  beginning  of  the  nineteenth  century,  for 
instance,  combinations  of  workmen  to  improve  their  conditions 
of  employment  were  unlawful.  There  was  obvious  necessity 
for  labor  laws,  therefore,  to  legalize  combination  and  make  col- 
lective bargaining  legitimate.  But  certain  classes,  particularly 
women  and  child  wage  workers,  have  found  it  nearly  impossible 
to  organize  for  collective  bargaining.  In  their  case  the  state 
has  entered  upon  a  program  of  positive  protection,  acting  so 
far  as  children  are  concerned  in  loco  parentis.  Adult  men,  with 
their  trade  unions,  have  been  left  very  largely  to  take  care  of 
themselves;  but  trade  unions,  occupied  with  the  absorbing 
questions  of  wages  and  hours  of  labor,  frequently  show  marked 
indifference  towards  certain  conditions  of  employment,  such 
as  safety  and  sanitation,  which  from  the  public  standpoint 
are  highly  important.  Of  these  conditions  the  public  in  its 
own  interest  has  been  forced  to  take  cognizance.  Finally, 
legislative  enactments  have  been  used  both  to  foster  thrift, 
thus  placing  the  workman  in  a  better  position  to  protect  his 
own  interests,  and  to  maintain  uniform  conditions  of  employ- 
ment, so  that  industry  shall  be  conducted  under  uniform  rules. 
To  most  employers,  for  instance,  it  makes  very  little  difference 
whether  they  are  permitted  to  hire  children  under  fourteen 

47i 


472  OUTLINES  OF  ECONOMICS 

years  of  age  or  not ;  but  it  is  very  important  to  them  that  they 
should  not  be  bound  by  more  onerous  restrictions  than  are 
imposed  upon  their  competitors.  From  this  and  some  other 
standpoints,  the  universality  and  rigidity  of  the  labor  law  are 
virtues :  the  stricter  its  enforcement  and  the  wider  the  area  of 
competition  to  which  it  applies,  the  better. 

Freedom  of  Combination,  Conspiracy,  and  Injunctions.  —  In 
the  early  part  of  the  nineteenth  century,  peaceable  combina- 
tions of  workmen  to  better  the  conditions  of  employment  were 
illegal  both  in  England  and  the  United  States.  Before  the 
middle  of  the  nineteenth  century,  however,  our  higher  courts 
had  established  the  doctrine  that  workingmen  might  peaceably 
combine  to  secure  higher  wages,  reduce  hours,  or  improve  shop 
and  other  conditions  of  employment  immediately  affecting 
themselves.  The  trade  union  acquired  a  lawful  status.  But 
it  must  not  be  supposed  that  in  the  United  States  this  freedom 
was  or  is  complete.  Workmen  might  combine  to  secure  higher 
wages,  and  might  enforce  their  demands  by  striking,  but  in 
most  jurisdictions  they  could  not  lawfully  combine  to  secure 
the  discharge  of  a  non-union  man,  nor  could  they  threaten  in 
concert  to  quit  dealings  with  a  merchant  unless  he  should  refuse 
to  buy  goods  from  some  manufacturer  against  whom  these 
workmen  or  their  friends  were  striking.  Moreover,  the  move- 
ment towards  complete  freedom  was  blocked  or  delayed  in  the 
last  quarter  of  the  nineteenth  century  by  the  widespread  adop- 
tion of  anti-trust  laws,  prohibiting  combinations  in  restraint 
of  trade.  Many  of  the  customary  activities  of  trade  unions, 
such  as  strikes  to  enforce  the  closed-shop  rule,  publication  of 
"  unfair  lists,"  and  the  like,  are  regarded  in  some  jurisdictions 
as  restraints  of  trade.  The  anti-trust  laws  thus  threw  a  cloud 
upon  the  whole  trade  union  movement.  Finally  the  whole 
situation  was  complicated  and  embittered  by  a  doubtful  use  of 
the  injunction  and  by  the  uncertainty  of  the  law  itself.  Statutes 
differ,  and  the  interpretations  of  similar  statutes  by  different 
courts  are  in  hopeless  conflict.  This  confusion  constitutes  in 
itself  a  grave  social  problem. 

We  have  already  recorded  the  simple  solution  of  this  problem 


LABOR   LEGISLATION  473 

reached  in  England : l  in  labor  disputes  workmen  or  employers 
may  lawfully  do  in  combination  whatever  any  employee  or 
employer  may  lawfully  do  alone.  In  this  country  several 
state  legislatures  and  Congress  (so  far  as  federal  law  is  concerned) 
have  attempted  to  enact  the  same  general  principles  into  law; 
but  the  Massachusetts  law  on  this  subject  has  been  declared 
unconstitutional  by  the  Supreme  Court  of  that  state,  and  in 
the  opinion  of  many  authorities  the  federal  law  is  likely  to  meet 
a  similar  fate.  The  Massachusetts  decision  rests  on  the  general 
argument  that  the  right  to  work  is  property,  that  state  and 
federal  constitutions  prevent  any  person  from  being  deprived 
of  property  without  compensation  or  due  process  of  law,  that 
combinations  of  workmen  are  frequently  used  to  prevent  per- 
sons from  obtaining  work,  and  that  no  such  combination  can 
be  legitimatized  by  mere  statute  law.  Whether  the  federal  law 
on  the  subject  —  which  is  contained  in  the  Clayton  Anti-trust 
Act  —  will  be  similarly  emasculated,  it  is  impossible  to  say ; 
but  as  this  law  is  regarded  by  many  labor  leaders  as  the  Magna 
Charta  of  the  American  labor  movement,  and  as  its  provisions 
relating  to  the  injunction,  at  least,  are  likely  to  be  sanctioned  by 
the  courts,  so  much  of  the  act  as  relates  to  labor  combina- 
tions and  injunctions  has  been  briefly  summarized  below.  Each 
provision  of  the  law,  it  may  be  noted,  records  a  legislative 
verdict  upon  some  hotly  contested  point ;  and  interpreted  in 
this  light  the  Clayton  Act  becomes  a  valuable  historical  sum- 
mary as  well  as  a  statement  of  the  present  federal  law. 

"The  labor  of  a  human  being  is  not  a  commodity  or  article  of  commerce." 
Labor  organizations  shall  not  be  construed  to  be  illegal  combinations  or 
conspiracies  in  restraint  of  trade  under  federal  anti-trust  laws. 

"No  preliminary  injunction  shall  be  issued  without  notice  to  the  opposite 
party."  No  temporary  restraining  order  shall  be  granted  without  similar 
notice,  unless  it  shall  specifically  shov/  that  immediate  and  irreparable  injury 
will  result  bef  .re  notice  can  be  served  a-.d  a  hearing  had  thereon  :  and  every 
temporary  restraining  order  granted  shall  define  the  injury,  state  why  it  is- 
irreparable  and  why  the  order  was  granted  without  notice,  shall  expire  in 
not  more  than  ten  days  unless  extended  for  good  cause,  and  shall  provide  for 
a  hearing  (on  whether  a  Dreliminary  injunction  shall  issue)  which  shall  take 

1  P.  58. 


474  OUTLINES   OF  ECONOMICS 

precedence  of  all  matters  before  the  court  except  older  matters  of  the  same 
character.  Proper  bonds  shall  be  executed  to  compensate  for  damages 
resulting  from  an  injunction  improvidently  granted;  every  injunction  or 
restraining  order  shall  describe  specifically  and  in  reasonable  detail  the  act 
sought  to  be  restrained ;  and  shall  be  binding  only  upon  the  parties  to  the 
suit,  their  officers,  agents,  servants,  employees,  and  attorneys,  or  those  par- 
ticipating with  them,  and  who  shall  have  received  actual  notice  of  the  same. 
In  contempt  proceedings  for  violating  any  injunction  or  order  forbidding 
an  act  which  is  also  a  criminal  offense,  the  accused  may  demand  trial  by  jury, 
and  penalties  are  limited,  in  the  case  of  natural  persons.  Judgments  of  con- 
viction may  be  reviewed  upon  writ  of  error  as  in  criminal  cases ;  but  these 
provisions  do  not  relate  to  contempts  committed  in  the  presence  of  the  court, 
nor  to  contempts  committed  in  disobedience  of  any  lawful  order  entered  in 
any  suit  prosecuted  on  behalf  of  the  United  States. 

"And  no  such  restraining  order  or  injunction  (i.e.  in  labor  disputes)  shall 
prohibit  any  person  or  persons,  whether  singly  or  in  concert,  from  terminat- 
ing any  relation  of  employment,  or  from  ceasing  to  perform  any  work  or 
labor,  or  from  recommending,  advising,  or  persuading  others  by  peaceful 
means  so  to  do ;  or  from  attending  at  any  place  where  any  such  person  or 
persons  may  lawfully  be,  for  the  purpose  of  peacefully  obtaining  or  com- 
municating information,  or  from  peacefully  persuading  any  person  to  work 
or  to  abstain  from  working ;  or  from  ceasing  to  patronize  or  to  employ  any 
party  to  such  dispute,  or  from  recommending,  advising,  or  persuading  others 
by  peaceful  and  lawful  means  so  to  do ;  or  from  paying  or  giving  to,  or  with- 
holding from,  any  person  engaged  in  such  dispute,  any  strike  benefits  or  other 
moneys  or  things  of  value ;  or  from  peaceably  assembling  in  a  lawful  manner, 
and  for  lawful  purposes;  or  from  doing  any  act  or  thing  which  might  lawfully 
be  done  in  the  absen-ce  of  such  dispute  by  any  party  thereto;  nor  shall  any  of 
the  acts  specified  in  this  paragraph  be  considered  or  held  to  be  violations  of  any 
law  of  the  United  States." 

The  most  important  provisions  of  the  Clayton  Act  are  those 
which  we  have  italicized  and  which  apparently  provide  that  a 
combination  of  workmen  may  lawfully  do  in  a  labor  dispute 
anything  that  any  party  thereto  might  lawfully  do  in  the 
absence  of  the  dispute.  Whether  this  is  wise  or  not  time  alone 
can  tell.  On  the  surface  everything  seems  to  support  the  con- 
clusion that  men  in  concert  should  be  permitted  to  do  what 
they  may  do  singly.  If  the  right  to  work  is  property,  so  also 
is  the  right  to  quit  work,  and  both  are  equally  guaranteed  by 
the  federal  constitution.  An  individual  not  under  contract 
may  quit  working  for  an  employer  or  dealing  with  a  merchant 


LABOR   LEGISLATION  475 

for  any  reason  or  no  reason.  Why,  it  is  confidently  asked, 
may  groups  of  men  not  do  the  same?  As  a  railroad  engineer 
may  quit  work  practically  when  he  likes,  why  should  not  the 
Brotherhood  of  Locomotive  Engineers  quit  work  as  a  body  when 
it  pleases  the  organization,  and  thus  tie  up  the  entire  railroad 
traffic  of  the  country,  for  the  purpose,  say,  of  assisting  the  rail- 
road conductors  of  one  district  in  refusing  traffic  from  another 
district  in  which  a  strike  has  been  declared? 

These  questions  carry  in  part  their  own  answer.  Many 
acts  which  are  either  harmless  or  trivial  when  performed  by  an 
individual  become  exceedingly  injurious  when  swollen  by 
concert  and  combination.  A  general  strike  or  boycott  for 
trivial  or  malicious  ends  cannot  by  logic-chopping  be  made 
anything  else  than  impolitic  and  wrong.  All  this  appears 
plain  when  we  reverse  the  case  and  pass  judgment  upon  what 
are  practically  the  same  acts  when  performed  by  employers. 
A  sympathetic  lockout,  ordered  against  one  innocent  union, 
say  of  freight  handlers,  in  order  to  prevent  them  from  voting 
funds  to  assist  the  strike  of  a  union  of  railroad  telegraphers, 
for  instance,  would  bring  general  criticism  against  the  employers 
who  ordered  it;  but  it  is  essentially  the  same  in  principle  as 
the  sympathetic  strike.  The  black-list  —  which  has  almost 
no  avowed  friends  —  is  in  essence  similar  to  the  indirect  boy- 
cott or  strike  to  secure  the  discharge  of  a  non-union  man.  The 
simple  truth  is  that  many  things  are  dangerous  when  partici- 
pated in  by  great  numbers,  which  are  not  so  when  performed 
by  individuals. 

The  Clayton  Act  does  not  remove  all  the  safeguards  against 
harmful  combination.  Most  of  the  states  still  have  anti- 
trust acts  and  laws  against  unlawful  combination.  Moreover, 
if  we  have  not  had  general  strikes  and  nation-wide  boycotts  in 
the  past,  it  is  not  because  the  laws  or  the  court  decisions  have 
prevented  them.  The  inherent  difficulties  in  the  way  of  their 
successful  consummation,  and  the  sense  of  social  responsibility 
among  trade  unionists  and  the  working  classes  generally,  furnish 
the  real  protection.  The  real  danger  is  that  the  new  legisla- 
tion will  be  interpreted  as  creating  sound  moral  sanctions  for 


476  OUTLINES   OF   ECONOMICS 

things  which  may  be  inherently  unfair  or  immoral.  If  trade 
unionists  and  employers  do  not  permit  this  legislation  to  blind 
their  moral  judgments,  and  remember  that  the  removal  of  a 
legal  ban  from  an  action  does  not  necessarily  make  that  action 
under  all  circumstances  either  expedient  or  justifiable,  then  it 
is  probable  on  the  whole  that  the  new  legislation  will  result  in 
more  good  than  harm. 

The  new  law  has  the  virtue  of  equalizing  things.  The  sym- 
pathetic lockout  and  the  black-list  cannot  in  practice  be  denied 
to  the  employers.  They  can  use  them  because  they  can  use 
them  secretly ;  because  the  president  of  a  great  corporation  or  a 
small  board  of  directors  may  maintain  a  black-list  or  order  a 
sympathetic  lockout  so  quietly  that  it  would  be  impossible  to 
prove  their  nature  or  for  exactly  what  purposes  they  were 
declared.  The  trade  union,  on  the  other  hand,  must  act  in 
open  concert,  after  legislative  action,  the  nature  and  purpose 
of  which  can  with  difficulty  be  concealed.  Many  of  the  pro- 
ceedings must  be  formally  recorded.  The  new  federal  law 
puts  the  employer  and  the  union  on  a  more  equal  footing;  al- 
though it  ignores  the  vast  interests  of  the  public  and  removes 
legal  penalties  from  actions  which  are  often  morally  wrong 
and  socially  dangerous.  In  the  end  it  will  probably  lead  to  the 
full  exercise  by  the  state  of  the  right  to  suppress  any  black-list, 
lockout,  strike,  or  boycott  which  becomes  so  extensive  or 
offensive  as  to  shock  the  public  sense  of  fair  play  or  seriously 
menace  public  welfare. 

Child  Labor  Laws.  —  The  class  of  laws  which  we  have  been 
considering  has  been  designed  to  relieve  the  laborer  from  ancient 
disabilities,  so  that  he  may  be  enabled  in  combination  with 
his  fellows  to  help  himself.  Most  modern  labor  laws,  however, 
are  of  a  different  type.  They  assume  that  the  welfare  of  labor 
is  of  peculiar  importance  to  society  and  that  the  state  is  there- 
fore warranted  in  protecting  the  wage-earning  classes,  openly 
and  frankly.  Perhaps  the  earliest  and  most  typical  legisla- 
tion enacted  in  this  spirit  is  the  child  labor  law. 

The  problem  of  child  labor  is  frequently  misconstrued.  The 
principal  reason  why  children  work  is  not  found  in  the  needy 


LABOR  LEGISLATION  477 

widow,  the  abandoned  wife,  or  the  stony-hearted  employer. 
The  principal  causes  of  child  labor  are  the  restlessness  of  the 
child ;  the  failure  of  ordinary  school  training  to  hold  his  atten- 
tion and  arouse  his  ambition ;  and  the  ignorance  or  selfishness 
of  parents.  And  the  evil  consists,  principally,  in  the  fact  that 
the  child  who  goes  to  work  early  usually  gets  into  a  "  blind 
alley  "  occupation,  and  is  thus  prevented  from  developing  his 
full  potential  earning  power.  His  ability  to  serve  both  himself 
and  society  is  curtailed  by  his  excessively  early  start.  "  The 
better  occupation  either  will  not  receive  the  young  child  at  all, 
or  wants  him  with  more  schooling,  or  offers  such  a  low  initial 
wage  that  both  child  and  parent  turn  to  the  mill,  with  its  greater 
present  wage  opportunities." *  The  wage  in  the  low-grade 
occupation  is  at  first  relatively  high,  but  in  three  or  four  years 
the  boy  has  reached  his  maximum  earning  capacity  and  early 
marriage  fastens  him  to  the  job.  The  boy  who  begins  at  six- 
teen years  or  later  soon  catches  his  less  fortunate  brother,  and 
in  a  comparatively  few  years  is  earning  a  superior  wage.  As 
a  foundation  for  real  promotion  and  advancement  the  work 
which  children  between  fourteen  and  sixteen  years  of  age  do 
has  usually  little  value. 

It  is  thus  plain  that  the  problem  of  child  labor  is  positive 
and  constructive,  not  merely  negative.  It  avails  little  to  pro- 
hibit children  from  working  at  this  or  that;  agencies  must  be 
provided  helpfully  to  guide  their  activities.  Already  the 
most  advanced  states  have  incorporated  in  their  laws  a  pro- 
vision requiring  employers  of  child  labor  to  give  the  children 
a  specified  amount  of  vocational  training,  or  time  co  secure 
such  training,  in  institutions  provided  by  the  state.  More 
important  still,  agencies  are  being  established  to  determine  by 
physical  and  psychological  tests  whether  children  who  have  com- 
pleted the  required  schooling  are  really  fitted  to  enter  industry, 
and  what   kinds  of  work  they  are  best  fitted  to  undertake.2 

1  Susan  M.  Kingsbury,  "The  Relation  of  Children  to  the  Industries,"  in  Report 
tf  Massachusetts  Commission  on  Industrial  and  Technical  Education,  p.  44. 

1  See  Mental  and  Physical  Measurements  of  Working  Children,  by  Helen  Thompson 
Wooley  and  Charlotte  Rust  Fischer. 


478  OUTLINES   OF   ECONOMICS 

The  beginnings  are  tentative  and  the  work  difficult.  But 
the  period  draws  to  an  end  in  which  ignorant  children  drift 
or  are  pushed  by  ignorant  parents  into  the  work  which  lies 
nearest  at  hand ;  and  the  time  approaches  when  the  most  care- 
ful thought  will  be  given  to  the  selection  of  one's  life  work  and 
the  training  for  it. 

Child  labor  laws  differ  greatly  in  the  different  states,  and  the 
resulting  inequality  of  burden  upon  competing  employers  so 
complicates  the  problem  that,  in  1916,  Congress  enacted  a  law 
debarring  from  interstate  commerce  goods  produced  by  very 
young  children  —  leaving  each  state  to  legislate  as  it  sees  fit 
about  products  confined  to  intrastate  trade.  This,  in  our 
opinion,  should  be  productive  of  far  more  good  than  evil.  But 
the  constitutionality  of  this  new  federal  legislation  is  involved 
in  grave  doubt,  and  the  new  statute  is  in  some  respects 
unfortunately  worded,  so  that  its  exact  scope  is  not  yet 
clear. 

A  good  state  child  labor  law,  it  is  now  generally  conceded, 
should  prohibit  the  employment  of  all  children  under  fourteen, 
and  of  all  children  under  a  higher  age  limit  who  are  undersized, 
weakly,  or  illiterate.  "  Young  persons  "  who  are  deficient  in 
the  fundamental  requirements  of  an  English  education  should 
be  compelled,  where  possible,  to  attend  a  continuation  school. 
Work  in  "  immoral "  or  dangerous  occupations,  at  night,  or  in 
excess  of  eight  hours  per  day  should  be  forbidden  for  all  children 
under  the  higher  age  limit. 

The  successful  enforcement  of  such  laws  has  been  found  diffi- 
cult. Birth  or  baptismal  certificates,  or  other  similar  evidences 
of  age,  have  to  be  procured  from  parents ;  certificates  of  attend- 
ance and  proficiency  from  school  authorities;  examinations 
of  health  and  educational  requirements  must  be  made;  and 
employers  required  to  demand,  file,  and  return  employment 
certificates.  The  community  must  maintain  and  properly 
support  factory  inspectors  and  health  and  school  attendance 
officers  in  adequate  numbers,  with  power  to  prosecute  viola- 
tions of  the  law  and  with  secure  tenure  of  office.  The  com- 
munity should  further  provide  for  dependent  families  which 


LABOR   LEGISLATION  479 

need  the  earnings  of  their  children,  keep  birth  records,  and 
maintain  schools  fitted  to  hold  the  attention  of  the  child  and 
properly  train  him  for  his  life  work.  "  The  best  child  labor 
law  is  a  compulsory  school  law  covering  forty  weeks  in  the  year 
and  requiring  the  attendance  of  all  children  under  fourteen  years 
of  age."  l 

The  Labor  of  Women.  —  The  labor  of  women  is  not  in  itself 
a  problem  which  calls  for  legislation.  The  evil  consists  in  work- 
ing under  conditions  which  undermine  health  and  morals,  or 
for  inadequate  wages.  It  is  impossible  to  describe  here  in 
detail  the  various  laws  which  have  been  passed  relating  to  the 
employment  of  women.  Women  are  subject  to  the  "  factory 
acts  "  relating  to  sanitation,  safety,  and  occupational  diseases, 
and  to  general  statutes  regulating  production  in  tenement 
houses  and  the  time,  frequency,  and  character  of  wage  pay- 
ments. In  the  more  advanced  states  also,  the  labor  of  women 
in  manufacturing,  mechanical,  and  mercantile  establishments 
is  likely  to  be  safeguarded  by  laws  limiting  the  hours  of  labor, 
prohibiting  night  work  and  continuous  employment  for  more 
than  six  hours,  for  example,  without  an  interval  for  meals ;  provid- 
ing and  permitting  the  use  of  suitable  seats ;  requiring  separate 
and  sanitary  toilet  facilities;  prohibiting  the  employment 
(knowingly)  of  women  within  two  weeks  before  or  four  weeks 
after  childbirth ;  and  —  in  Massachusetts  for  example  — 
directing  local  authorities  to  furnish  responsible  mothers  having 
dependent  children  sufficient  aid  "  to  enable  the  mothers  to 
bring  up  their  children  properly  in  their  own  homes." 

Until  very  recent  years,  regulations  similar  to  the  above 
represented  the  extreme  limit  to  which  any  American  state 
had  gone  in  the  protection  of  women.  And  even  the  consti- 
tutionality of  such  regulation  was  in  grave  doubt,  for  an  im- 
portant statute  limiting  the  hours  of  labor  had  been  declared 
unconstitutional  by  the  highest  court  in  Illinois,  and  in  New 
York  a  statute  prohibiting  night  work  had  been  similarly 
annulled,  on  the  general  grounds  that  they  infringed  the  free- 

1  Cf.  Florence  Kelly,  Some  Ethical  Gains  Through  Labor  Legislation,  pp.  98,  99, 
and  passim. 


480  OUTLINES   OF   ECONOMICS 

dora  of  contract  and  were  "  unduly  discriminatory  between 
citizens,"  the  court  remarking  (in  the  New  York  decision)  "  that 
woman  is  no  more  the  ward  of  the  state  than  is  man."  But 
under  the  more  liberal  leadership  of  the  Supreme  Court  of 
the  United  States,  both  of  the  state  courts  in  question  have 
recently  reversed  these  decisions  and  have  sanctioned  similar 
laws  as  reasonable  health  regulations,  looking  not  only  to  the 
protection  of  the  individual  woman  but  to  the  "  welfare  of  the 
race."  *  . 

Minimum  Wage  Laws  for  Women.  —  In  about  a  fourth  of 
the  states  minimum  wage  laws  have  been  passed,  with  the  gen- 
eral object  of  requiring  that  wages  paid  in  certain  occupations 
shall  be  sufficient  to  provide  for  a  woman's  normal  needs  "  re- 
garded as  a  human  being  living  in  a  civilized  community." 
Whether  these  statutes  will  be  effective  time  alone  can  tell,  but 
their  passage  marks  a  revolution  in  the  social  and  legislative 
philosophy  of  this  country. 

Minimum  wage  laws  were  first  adopted  by  the  Australian 
state  of  Victoria  in  1896  to  regulate  wages  and  other  conditions 
of  labor  in  the  "  sweated  trades."  Trades  or  industries  in 
which  wages  are  particularly  low  are  usually  singled  out  by 
legislation,  though  in  Victoria  the  government  may  apply  the 
system  to  additional  trades  by  administrative  order.  These 
wage  boards,  as  we  have  seen  in  the  preceding  chapter,  are 
designed  to  induce  compulsory  collective  bargaining,  in  which 
the  state  participates  by  compelling  employers  and  employees 
to  fix  standard  conditions  of  employment.  In  England  and 
this  country  the  legislation  is  as  yet  much  more  tentative 
and  restricted.  "  The  outstanding  characteristics  of  the  Ameri- 
can minimum  wage  legislation  compared  with  that  of  Eng- 
land, Australia,  and  New  Zealand  are  these:  The  first  is 
its  omission  of  men ;  the  second  is  its  reference  to  the 
welfare  of  the  people  as  a  whole;  the  third,  which  is  re- 
sponsible for  both  the  others,  is  its  subordination  to  the  courts 
on  the  grounds  of  constitutionality,  entailing  the  practice  of 
placing  upon  American  states  the  burden  of  proof  that  they 

1  L.  D.  Clark,  The  Law  of  the  Employment  of  Labor,  p.  103. 


LABOR   LEGISLATION  48 1 

are  acting  within  their  police  powers  when  they  create  such 
wage  commissions  and  wage  boards  or  conferences."  l  Some 
of  the  American  laws,  it  may  be  added,  make  no  provisions  for 
joint  wage  boards  of  the  Australasian  type,  but  provide  that 
the  minimum  wage  shall  be  fixed  directly  by  a  state  labor  or 
industrial  commission. 

The  general  principles  of  minimum  wage  legislation  are 
simple.  In  many  trades  the  majority  of  the  workers  do  not 
receive  enough  wages  to  maintain  their  physical  efficiency.  Of 
these  sub-standard  wage  workers  a  large  number  are  partially 
supported  by  other  members  of  the  family,  a  considerable  num- 
ber are  assisted  by  charity,  a  few  eke  out  their  living  by  inter- 
mittent or  regular  prostitution,  and  some  "  actually  die  of 
under-nutrition  and  worry."  2  The  work  as  a  rule  is  simple 
and  the  supply  of  labor  excessive.  Usually  there  is  no  labor 
organization.  The  workers  are  weak  and  the  wage  is  fixed 
by  individual  bargaining  in  which  the  predominant  force  is 
sometimes  the  rapacity  of  the  employer.  The  tendency  towards 
a  uniform  or  standard  wage  in  many  of  these  trades  seems  to 
have  been  checked  by  the  absence  of  labor  organization,  and 
competing  establishments  in  the  same  industry  are  found  again 
and  again  paying  strikingly  different  wages  for  the  same  grade 
of  labor. 

It  is  held,  in  short,  that  trades  which  pay  less  than  a  living 
wage  are  parasitic ;  that  they  constitute  a  positive  drain  upon 
society  at  large,  and  that  any  measures  necessary  to  place  these 
trades  on  a  self-supporting  basis  are  both  justifiable  and  econom- 
ically heipful.  The  establishment  of  a  minimum  wage  is 
expected  to  force  a  certain  number  of  slow  and  incompetent 
workers  out  of  employment,  although  provision  is  usually 
made  to  permit  them  to  work  under  special  permits.  But 
that  society  should  be  forced  openly  and  frankly  to  deal  with 
and  take  care  of  its  incompetent  workers  is  regarded  as  an  ad- 
vantage.    It  is  expected  that  such  legislation  in  some  instances 

1  Florence  Kelley,  in  The  Survey,  vol.  xxxiii,  p.  487. 

5 II.  R.  Seagcr,  "The  Theory  of  the  Minimum  Wage,"  American  Labor  Legislation 
Review,  vol.  iii,  No.  1,  p.  84. 


482  OUTLINES   OF   ECONOMICS 

will  result  in  increased  prices.  But  the  consumer  is  expected 
to  bear  his  fair  share  in  supporting  those  who  supply  his  needs, 
and  both  a  priori  analysis  and  experience  in  Australia  and  Eng- 
land make  it  probable  that  the  rise  of  wages  would  not  be 
accompanied  by  a  corresponding  rise  in  prices.1  Finally  it 
is  expected  that  the  increase  in  wages  will  compel  reorganization 
of  the  parasitical  trades  so  that  in  the  end  the  cost  of  produc- 
tion will  be  decreased  rather  than  increased.  Incidentally 
the  operation  of  the  wage  boards  is  expected  to  stimulate  or- 
ganization among  the  wage  workers  concerned  and  to  react 
favorably  upon  immigration.  Immigrants  are  less  likely  to 
come,  many  believe,  if  they  know  in  advance  that  they  must 
be  able  to  earn  the  minimum  wage  or  else  leave  the  country. 
Price  cutting  in  the  labor  market  will  be  checked;  and  the 
increase  in  wages  will  focus  competition  upon  the  quality  and 
efficiency  of  the  laborer.  Most  important  of  all,  perhaps,  the 
system  is  expected  to  compel  a  wider  and  more  effective  use  of 
labor-saving  machinery. 

Minimum  wage  legislation  slowly  introduced  and  carefully 
administered  meets  the  test  both  of  economic  theory  and  actual 
experience.  In  Victoria  the  legislation  which  was  at  first 
doubtfully  applied  to  six  trades  has  now  been  made  applicable 
to  141 ;  and  150,000  workers  in  a  population  numbering  less 
than  one  and  one  half  million  "  have  the  minimum  wages  in 
their  trades  prescribed  by  law."  Vigorously  opposed  by  the 
employers  on  its  introduction,  it  seems  from  reports  of  disin- 
terested investigators  to  have  established  itself  on  a  firm  founda- 
tion. There  is  yet  some  opposition  to  details  of  the  law  and 
vigorous  criticism  of  the  way  in  which  it  is  administered;  but 
from  all  that  can  be  learned  those  who  desire  to  do  away  with 
this  system  of  regulation  constitute  a  very  small  minority.  In 
England  the  results  seem  equally  favorable.  Nothing  revo- 
lutionary has  been  accomplished,  but  the  system  has  demon- 
strated that  it  is  practicable,  even  in  highly  complicated  trades; 
that  it  can  be  trusted  to  raise  wages  without  seriously  disturb- 
ing prices ;  that  it  mildly  stimulates  organization  among  work- 
1  Cf.  N.  I.  Stonf  '«  The  Suney,  vol.  xxxiii,  p.  514. 


LABOR   LEGISLATION  483 

ers  who  need  organized  effort  to  better  themselves;  that  it 
compels  serious  study  and  public  investigation  of  trades  which 
need  both ;  and  that  it  is  not  productive  of  serious  evils.  The 
minimum  wage  has  not  become  the  maximum  nor  has  the 
operation  of  the  act  resulted  "  in  wholesale  dismissals  of  old 
and  slow  workers.  The  predominant  method  of  payment  in 
the  scheduled  trades  is  by  piece,  and  where  this  is  the  case  the 
employer  who  has  fixed  piece  rates  yielding  the  equivalent  of 
the  time  rate  to  the  '  ordinary  worker  '  runs  no  risk  of  penalty 
if  his  sub-ordinary  worker  fails  to  reach  that  amount  by  reason 
of  incapacity  or  advanced  age."  1 

So  far  as  economic  theory  is  concerned,  there  is  no  reason 
to  believe  the  minimum  wage  proposition  unsound.  The  es- 
tablishment of  minimum  standards  of  sanitation  and  safety  in 
Germany  does  not  seem  to  have  hurt  industry  there,  and  there 
is  no  reason  to  believe  that  the  establishment  of  minimum  wage 
standards  would  do  so.  Without  regulation  much  of  the  com- 
petitive fight  centers  about  the  mere  money  wage.  A  poor 
workman  may  be  more  profitable  to  the  employer  than  a  skilled 
workman  provided  the  poor  workman  can  be  secured  for  a  small 
enough  fraction  of  the  wage  it  would  be  necessary  to  pay  to 
the  skilled  workman.  Establish  a  dead  line  —  or  better,  a 
health  line  —  and  the  emphasis  will  be  placed  upon  efficiency 
instead  of  cheapness.  Wage  earners  will  have  to  meet  higher 
and  better  standards.  The  competitive  struggle  will  thus 
operate  to  evoke  efficient  rather  than  low-paid  workmen. 
And  the  higher  cost  of  labor  will  help  to  force  the  introduction 
of  better  machinery  and  better  methods  of  organization. 

Obviously,  not  all  the  claims  made  for  this  system  will  bear 
scientific  scrutiny.  There  is,  for  instance,  probably  more 
error  than  truth  in  the  contention  that  every  industry  which 
pays  its  minor  workers  less  than  a  living  wage  is  a  detriment 
rather  than  a  help,  an  industrial  parasite  sopping  the  economic 
strength  of  a  community.  Until  a  far  better  distribution  of 
the  labor  force  has  been  secured,  there  will  continue  to  be  in 

1  Constance  Smith,  "Working  of  the  Trade  Boards  Act,"  Journal  of  Political 
Economy,  vol.  xxii,  p.  625. 


484  OUTLINES  OF   ECONOMICS 

all  probability  a  surplus  of  workers  who  cannot  earn  a  living 
wage  and  yet  had  better  earn  a  supplementary  wage  than  be 
idle.  There  were  in  1910,  for  instance,  in  this  country  1,847,600 
females  between  the  ages  of  16  and  20,  inclusive,  engaged  in 
gainful  occupations.  Young  women  might  possibly  better 
spend  these  years  in  training  for  their  life-work,  including  house- 
keeping and  the  difficult  vocation  of  marriage.  But  until 
adequate  provision  for  such  training  is  made,  young  women  of 
this  age  had  better  be  employed  at  wages  which  will  tend  to 
make  the  family  income  more  adequate  than  not  to  be  employed 
at  all.  After  all,  however,  these  are  minor  modifications  of 
the  theory  upon  which  the  minimum  wage  program  rests. 
That  standards  should  be  adopted,  including  a  wage  standard, 
which  both  employers  and  employees  must  meet,  is  on  the  whole 
consistent  with  the  best  economic  and  social  theory. 

Some  trade  unionists  oppose  minimum  wage  laws  on  the 
grounds  that  the  minima  will  become  maxima  and  that  wages 
should  not  be  regulated  by  law.  But  the  first  charge  has  been 
disproved  by  experience,  and  the  minimum  wage  at  its  best  is 
a  program  for  compulsory  collective  bargaining,  not  for  the 
regulation  of  wages  by  statute.  It  aims  to  introduce  into  un- 
skilled vocations  what  are  essentially  trade-union  methods  of 
standardization,  and  the  criticisms  which  are  directed  against 
it  apply  equally  well  to  trade-union  procedure. 

Factory  Acts.  —  Constitutional  guarantees,  particularly  that 
of  free  contract,  prevent  in  this  country  the  general  regulation 
of  the  labor  of  adult  men,  but  under  the  police  power  the  states 
have  the  right,  indeed  in  the  language  of  the  Supreme  Court, 
"  it  is  among  their  plain  duties,"  to  regulate  the  physical  condi- 
tions of  employment  so  that  accidents  and  occupational  diseases 
may  be  minimized.  These  regulations,  frequently  referred  to 
as  factory  acts,  are  typified  by  the  familiar  laws  requiring  proper 
fire  escapes,  the  removal  of  dust  or  noxious  vapors  by  fans,  the 
placing  of  guards  about  dangerous  machinery,  the  installation 
of  mechanical  belt  shifters,  and  connection  by  bells  or  tubes 
between  rooms  in  which  machinery  is  used  and  the  engine  room. 
Such  laws  have  now  been  adopted  in  most  of  the  states,  but 


LABOR   LEGISLATION  485 

their  enforcement  in  many  states  has  been  very  ineffective. 
In  1 9 13  there  were  fifteen  states  with  nearly  a  million  wage 
earners  in  manufacturing  and  mechanical  industries  which  had 
practically  no  provision  for  factory  inspectors.  And  even 
where  factory  inspection  is  provided,  it  has  too  frequently  been 
half-hearted,  inexpert,  and  emasculated  by  political  interference. 
In  one  state,  "  where  the  chief  factory  inspector  divides  his  time 
between  conducting  a  livery  stable  he  owns  and  the  business  of 
caring  for  some  30,000  factory  wage  earners,  I  found  him  con- 
tributing a  remarkably  concise  annual  report  of  exactly  four- 
teen words.  It  reads,  under  date  of  July  1,  as  follows:  'I 
have  visited  the  same  factories  as  last  year  and  find  conditions 
the  same.'  "  * 

While  politics  and  administrative  ineptitude  have  seriously 
crippled  factory  regulation  in  this  country,  the  truth  is  that 
the  problem  was  a  new  and  difficult  one  and  that  there  were 
procurable  few  or  no  real  experts  until  very  recent  years.  Very 
recently,  however,  great  improvement  has  been  made  both 
in  the  laws  and  their  administration.  Wisconsin,  Massachu- 
setts, New  York,  and  other  states  have  gone  far  towards  solving 
the  administrative  problem  by  placing  appointments  on  the 
civil  service  basis  and  consolidating  powers  previously  lodged 
with  police,  factory  inspectors,  and  health  commissioners  into 
one  industrial  or  labor  commission,  with  general  power  to  enforce 
the  rules  necessary  to  provide  reasonable  sanitation  and  safety. 
In  this  way  the  necessary  elasticity  of  rule  and  standard  has 
been  secured ;  and  in  adopting  rules  or  standards  the  coopera- 
tion of  employers  and  labor  organizations  has  been  secured, 
thus  insuring  more  practical  rules  and  the  good  will  of  those  to 
whom  these  rules  apply.  Regulation  by  the  state  can  never 
become  effective  until  responsibility  and  power  are  centralized 
and  the  responsible  administrative  head  given  sufficient  dis- 
cretion nicely  to  adapt  regulations  to  the  subtle  complexities 
of  modern  industry.  With  employers,  employees,  and  factory 
inspectors  working  together  under  practicable  regulations  in 

1  E.  F.  Brown,  "The  Efficiency  of  Present  Factory  Inspection  Machinery  in 
the  United  States,"  American  Labor  Legislation  Review,  vol.  iii,  No.  i,  pp.  27-28. 


486  OUTLINES   OF   ECONOMICS 

whose  formulation  all  three  have  cooperated,  rapid  progress 
has  recently  been  made  in  the  prevention  of  accidents  and 
equally  gratifying  improvement  has  been  made  in  the  methods 
of  compensating  for  accidents. 

Employers'  Liability.  —  Under  the  common  law  of  employ- 
ers' liability,  the  employer  is  under  obligation  to  provide  his 
workmen  with  a  reasonably  safe  place  in  which  to  work,  with 
reasonably  safe  machinery,  and  with  reasonably  prudent  and 
competent  fellow  workmen ;  and  the  employer  is  liable  in 
damages  for  any  accident  to  his  workmen  resulting  from  failure 
to  display  this  ordinary  prudence  and  care,  as  well  as  from  the 
similar  failure  or  negligence  of  any  superintendent,  overseer, 
or  vice-principal  authorized  to  issue  orders  in  his  name.  When 
the  employer  has  observed  the  ordinary  precautions  of  a  reason- 
ably prudent  man,  however,  the  employee  assumes  all  the  haz- 
ards incident  to  the  employment  or  arising  from  the  negligence 
of  fellow  servants ;  and  even  though  the  employer  is  negligent, 
the  employee  cannot  recover  damages  for  an  accident,  if  the 
employee  was  aware  of  the  employer's  negligence  and  volun- 
tarily accepted  the  risk,  or  if  the  employee  has  been  guilty  of 
additional  or  contributory  negligence. 

This,  in  bare  outline,  is  the  common-law  foundation  of  the 
doctrine  of  employers'  liability.  It  has  been  modified  inces- 
santly by  statute  law  and  by  changing  interpretation  of  the 
courts ;  it  is  vague,  uncertain,  and  legalistic  in  the  worst  sense. 
Under  it  not  more  than  ten  per  cent  of  the  victims  of  indus- 
trial accidents  received  any  compensation,  and  of  the  damages 
paid  by  employers  the  victims  received  on  the  average  probably 
less  than  50  per  cent.  The  rest  went  for  court  costs  and  lawyers' 
fees.  A  class  of  professional  accident  attorneys,  "  ambulance 
chasers,"  who  exploited  industrial  accidents  for  their  own  rather 
than  the  victims'  benefit,  appeared  in  most  industrial  centers ; 
ignorant  juries  decided  on  the  difficult  facts  in  the  most  capri- 
cious ways,  now  refusing  relief  in  deserving  cases,  again  voting 
excessive  damages  for  trivial  or  perhaps  simulated  injuries; 
the  cases  filled  the  courts ;  decisions  turned  upon  hair-splitting 
distinctions  and  metaphysical  niceties;    the  humane  employer, 


LABOR   LEGISLATION  487 

the  conscientious  lawyer,  the  far-sighted  judge,  workingmen, 
and  the  general  public  became,  it  is  hardly  too  much  to  say, 
disgusted  with  the  inapplicability  and  bungling  unsuitability 
of  the  doctrine  of  employers'  liability  properly  to  deal  with  the 
grave  social  problem  arising  from  industrial  accidents. 

Attempts  to  solve  this  problem,  as  stated  above,  first  took 
the  form  of  incessant  amendment  of  the  old  law.  The  fellow- 
servant  doctrine  (that  the  employer  was  not  responsible  for 
accidents  arising  from  the  negligence  of  co-employees  as  distin- 
guished from  vice-principals)  was  curtailed  in  some  states  by 
confining  "  fellow  servants  "  to  those  employed  in  coordinate 
occupations  immediately  associated  with  the  victim,  and  the 
employer's  defenses  of  "  assumption  of  risk  "  and  "  contributory 
negligence  "  were  limited  and  in  some  jurisdictions  almost 
abolished.  But  the  truth  is  that  the  whole  social  philosophy 
underlying  the  law  of  employers'  liability  was  mistaken,  "  not 
so  much  unjust  as  wholly  inapplicable."  It  misconceived 
the  nature  of  the  social  problem  involved  and  offered  remedies 
that  were  wholly  ineffectual.  It  attempted  —  so  far  as  one 
can  discover  behind  it  any  real  rational  philosophy  —  to  single 
out  those  accidents  for  which  the  employer  was  to  blame  and 
to  compensate  workmen  in  accordance  with  the  damage  resulting 
from  the  employer's  negligence.  Investigation  shows,  however, 
that  the  employer  is  responsible  for  only  a  minority  of  the 
accidents  which  occur.  The  victim  himself,  his  fellow  workers, 
and,  most  important  of  all,  the  occupational  risk  itself  are  re- 
sponsible for  the  great  majority  of  accidents.  But  the  victim's 
need  and  that  of  his  family  are  just  as  great  when  the  accident 
results  from  the  victim's  negligence  as  when  it  results  from  the 
employer's  negligence.  It  is  not  a  question  of  individual  fault 
and  punishment  for  that  fault ;  it  is  a  question  of  industrial 
or  social  loss  and  insurance  against  that  loss.  The  government 
should  of  course  compel  both  employers  and  employees  to  take 
every  reasonable  precaution  against  accident,  by  unequivocal 
law  or  administrative  order ;  and  every  infraction  of  the  law 
should  lead  to  criminal  indictment,  not  civil  action.  But  even 
if  this  were  accomplished,   there  would  still  remain  a  large 


488  OUTLINES  OF   ECONOMICS 

number  of  industrial  accidents  which  if  not  compensated  for 
would  lead  to  poverty,  unemployment,  and  the  suffering  of 
innocent  women  and  children. 

That  the  burden  of  industrial  accidents  should  be  borne  by 
the  industry  itself  or  the  consumer  and  not  by  the  laborer  or 
his  family  is  very  generally  recognized ;  and  most  foreign  coun- 
tries, together  with  the  federal  government  and  more  than  half 
of  the  states,  have  replaced  or  supplemented  the  old  law  of 
employers'  liability  with  workmen's  compensation  acts.  The 
laws  are  described  and  discussed  in  a  later  chapter,  on  Insur- 
ance. They  have  worked  well :  not  perfectly,  but  with  much 
more  certainty  and  with  far  less  cost  than  the  old  laws.  Defects 
naturally  exist  in  the  new  system  which  should  be  remedied 
in  the  future.  The  usual  compensation  is  too  low  to  indemnify 
the  victim  and  his  family  adequately  for  the  loss  resulting  from 
the  accident,  and  the  limitation  of  payments  for  permanent 
disability  to  four  or  six  years  or  less  is  illogical  and  will  cause 
hardship.  But  the  new  system  is  so  much  superior  to  the  old 
that,  despite  these  defects,  its  adoption  must  be  regarded  as 
a  noteworthy  step  in  social  progress  achieved  through  legis- 
lation. As  a  concrete  contrast  with  the  awkward,  expensive, 
capricious  working  of  the  old  liability  law,  the  results  of  the 
operation  of  the  Wisconsin  compensation  act  during  the  year 
ended  June  30,  191 5,  are  suggestive  of  the  improvement  effected 
by  the  change.  Of  all  the  industrial  accidents  occurring  that 
year,  93  per  cent  were  settled  between  the  employers  and  work- 
men with  no  outside  interference  beyond  a  simple  "  approval  " 
by  the  state  Industrial  Commission ;  3  per  cent  of  the  cases 
were  carried  to  the  industrial  commission  for  adjustment ; 
and  only  one  fifth  of  1  per  cent  was  carried  to  the  courts.  The 
injured  workmen  received  for  indemnity  and  medical  expense 
Si, 3 50,000,  while  the  administrative  cost  to  the  state  was  only 

Philosophy  of  Labor  Legislation.  —  In  the  preceding  sketch 
it  has  been  possible  only  in  the  most  superficial  way  to  call 
attention  to  a  few  of  the  more  important  modern  labor  laws. 
It  is  equally  impossible  to  discuss  adequately  the  general  aspects 


LABOR  LEGISLATION  489 

of  the  labor  movement  as  it  expresses  itself  in  legislative  action. 
In  conclusion,  however,  it  may  be  suggestive  in  a  rather  dog- 
matic way  to  pass  in  review  some  of  the  broader  aspects  of  this 
movement : 

Mercantilism  and  its  alleged  failure,  or  the  breakdown  of 
old  labor  legislation  in  the  seventeenth  and  eighteenth  cen- 
turies, furnish  no  adequate  reason  for  concluding  that  the  new 
legislation  will  fail.  The  old  laws  were  enacted  by  a  ruling 
minority  in  behalf  of  that  minority.  They  had  to  contend 
with  the  persistent  and  growing  opposition  of  a  large  ma- 
jority of  the  people.  They  lay  athwart  the  path  of  democracy. 
The  new  laws  have  a  much  greater  chance  of  success  because 
they  cannot  be  passed  until  they  have  the  support  of  a  ma- 
jority, and  we  may  now  reasonably  look  for  an  administration 
thoroughly  in  sympathy  with  their  purposes. 

Administratively,  an  improved  mechanism  has  been  developed 
in  the  industrial,  labor,  or  welfare  commission.  From  the  stand- 
point of  labor  legislation  the  tripartite  division  of  American 
government  has  been  deeply  unfortunate.  Legislatures  have 
enacted  laws,  courts  have  passed  upon  them,  and  executives 
have  administered  them  who  did  not  understand  the  conditions 
and  technical  facts  with  which  they  dealt.  More  legislative 
power  and  more  judicial  power  must  be  lodged  in  labor  com- 
missions, manned  by  real  experts  (whom  we  are  just  beginning 
to  train)  and  empowered  to  deal  with  complex  labor  problems 
by  administrative  orders  or,  more  properly  perhaps,  legislative 
and  executive  orders.  The  original  formulation  of  general 
social  policy  must  be  left  to  the  legislature ;  ultimate  constitu- 
tional and  judicial  questions  must  remain  with  the  courts ;  but 
all  special  questions,  legislative,  judicial,  and  administrative, 
should  be  left  as  fully  as  possible  to  a  body  supplied  with  means 
and  time  to  learn  the  technical  facts  and  to  enlist  both  employers 
and  employees  in  formulating  and  then  observing  the  details 
of  the  law. 

So  far  as  constitutional  questions  are  concerned,  the  main 
battle  in  the  courts  has,  we  believe,  been  won.  Individualism 
and  freedom  of  contract  have  constituted  in  the  past  a  chronic 


490  OUTLINES   OF   ECONOMICS 

American  disease ;  but  an  adequate  antitoxin  has  been  developed 
in  the  police  power.  The  doctrine  of  the  police  power  raises 
essentially  a  question  of  fact :  does  the  condition  in  question  gen- 
uinely menace  the  health  or  morals  or  safety  of  the  community  ? 
Because  this  is  primarily  a  question  of  fact,  it  is  vitally  im- 
portant that  we  should  have  commissions  or  officials  empowered 
to  get  the  facts  in  an  impartial  and  authoritative  way.  When 
we  have  the  facts  we  shall  recognize  fully  that  "  liberty  "  is  a 
composite  and  mutually  contradictory  term;  that  there  are 
liberties  rather  than  one  single  liberty;  that  to  preserve  a 
deeper  and  more  genuine  liberty  we  must  frequently  sacrifice 
liberties  of  a  smaller  and  more  superficial  character,  and  to 
preserve  the  liberty  of  the  many  it  is  sometimes  necessary  to 
restrain  the  liberty  of  the  few.  If  there  is  an  inalienable  right 
of  free  contract,  may  an  individual  in  the  exercise  of  that  right 
bind  himself  to  slavery  for  life  ? 

Finally  it  is  being  found  that  this  protective  legislation  — 
protective  against  poverty  and  exploitation  either  by  persons 
or  circumstances  (the  last  is  far  the  more  important)  —  does 
not  pauperize  or  weaken  human  fiber,  or  check  the  competitive 
struggle  for  existence  upon  which  so  much  is  believed  to  depend. 
Underfeeding,  undereducation,  under  thinking,  all  the  hand- 
to-mouth  vicissitudes  that  accompany  abject  poverty,  under- 
mine human  fiber  and  pauperize  far  more  effectually  than  state 
regulation  or  assistance  can  ever  do.  Moreover,  the  modern 
labor  law  is  the  antithesis  of  paternalism.  It  is  the  collective 
way  by  which  the  wage-earning  masses  help  themselves;  and 
it  is  political  because  the  evil  which  it  seeks  to  remedy  is  political 
as  well  as  individual.  "  Of  all  national  resources  labor  is  by 
far  the  most  important.  So  important  is  it  that  one  may 
almost  say  that  all  else  depends  upon  it.  Not  until  a  nation 
has  secured  a  body  of  sturdy,  skillful  and  contented  workers 
can  it  be  said  to  have  met  the  first  requisite  to  national  efficiency. 
...  As  in  the  past  the  nation  that  would  succeed  had  to 
apply  itself  to  the  training  of  its  soldiers,  so  now  it  must  apply 
itself  to  the  training  of  its  industrial  workers.  We  are  appalled 
at  the  suffering,  loss  of  life,  and  destruction  of  wealth  entailed 


LABOR  LEGISLATION  49 1 

by  war  and  preparation  for  war.  They  are  as  nothing  compared 
with  the  misery,  sickness,  and  death  now  due  to  the  failure  of 
society  properly  to  control  the  conditions  under  which  industrial 
work  shall  be  performed.  No  one  can  calculate  the  loss  daily 
taking  place  as  the  result  of  the  use  of  feeble,  untrained,  dis- 
contented workers."  x  Labor  legislation  represents  above  all 
else  an  organized  effort  to  achieve  national  and  social  efficiency. 

QUESTIONS 

1.  Under  what  circumstances  is  the  labor  law  used  to  determine  condi- 
tions of  employment?  What  are  its  characteristics  in  this  connection? 
What  differences  are  found  in  the  determination  of  conditions  of  employ- 
ment by  law  and  by  a  strong  trade  union? 

2.  What  is  the  difference  between  a  primary  and  an  indirect  or  compound 
boycott?  Is  the  latter  lawful  in  the  jurisdiction  in  which  you  live?  Is  a 
strike  to  prevent  the  employment  of  non-union  men  lawful? 

3.  Does  the  anti-trust  act  of  your  state  apply  to  labor  organizations? 
What  is  a  conspiracy  ?  and  what  are  the  peculiar  characteristics  of  the  law 
of  conspiracy? 

4.  Against  what  aspects  or  characteristics  of  the  injunction  do  trade 
unionists  protest? 

5.  Summarize  the  child  labor  laws  of  your  state  and  those  relating  to 
industrial  education,  continuation  schools,  and  mothers'  pensions.  What 
arguments  have  been  advanced  against  mothers'  pensions? 

6.  Do  minimum  wage  laws  operate  to  reduce  all  wages  to  the  legal  min- 
imum? Summarize  evidence  on  this  point  from  the  Frankfurter-Goldmark 
brief  and  other  sources. 

7.  What  bearing  has  the  minimum  wage  on  the  immigration  problem? 
Is  it  socially  expedient  that  minors  living  in  families  with  adequate  incomes 
should  be  prohibited  from  working  for  less  than  the  living  wage? 

8.  Does  compulsory  insurance  against  sickness  and  old  age  tend  to  under- 
mine or  strengthen  individual  thrift?     Give  reasons. 

9.  Briefly  summarize  the  law  on  employers'  liability  in  your  state;  or 
if  it  has  a  workmen's  compensation  act,  summarize  the  results  of  that  law 
as  given  in  the  latest  published  statistics. 

REFERENCES 

(See  also  references  for  Chapter  XXII.) 

American  Labor  Legislation  Review  (quarterly). 

Andrews,  Irente.     Minimum  Wage  Legislation  (with  select  bibliography  on 
the  minimum  wage). 

1  W.  F.  Willoughby,  in  American  Labor  Legislation  Review,  vol.  iv,  p.  44. 


492  OUTLINES  OF  ECONOMICS 

Aves,  Ernest.  Report  to  the  Secretary  of  State  for  the  Home  Department  on 
Wages  Boards  and  Industrial  Conciliation  and  Arbitration  Acts  of  Aus- 
tralia and  New  Zealand. 

Beveridge,  W.  H.     Unemployment.   A  Problem  of  Industry. 

Clark,  L.  D.     Tlw  Law  of  the  Employment  of  Labor. 

Clark,  V.  S.     The  Labor  Movement  in  Australasia. 

Commons,  J.  R.,  and  Andrews,  J.  B.    Principles  of  Labor  Legislation. 

Dicey,  A.  V.  Relation  Between  Law  and  Public  Opinion  in  England  in  the 
Nineteenth  Century. 

Frankfurter,  Felix,  and  Goldmark,  Josephine.  The  Case  for  the 
Slwrter  Work  Day  (2  vols.).     (Brief  in  the  Oregon  ten-hour-law  case.) 

Goldmark,  Josephine.    Fatigue. 

Hutchins,  B.  L.,  and  Harrison,  A.    A  History  of  Factory  Legislation. 

Rubinow,  I.  M.     Social  Insuraiice. 

Stimson,  F.  J.  Popular  Law  Making;  Handbook  to  the  Labor  Law  of 
the  United  States. 

United  States  Bureau  of  Labor  Statistics.  Bulletin  (Separate  series  upon 
(a)  Labor  Laws  of  the  United  States  (including  decisions  of  courts 
relating  to  labor) ,  (b)  Foreign  Labor  Laws,  (c)  Workmen's  Insurance 
and  Compensation) ;  Report  on  Condition  of  Woman  and  Child  Wage 
Earners  in  the  United  States  (19  volumes). 

Webb,  Sidney  and  Beatrice.     The  Prevention  of  Destitution. 


CHAPTER  XXIV 

INTEREST 

Interest  is  the  price  paid  for  the  services  of  capital.  It  appears 
in  two  forms :  loan  interest,  the  amount  paid  by  one  man  to  an- 
other for  the  use  of  money  or  goods  owned  by  the  latter,  and 
imputed  interest,  that  portion  of  the  value  of  the  products  of 
industry  which  is  attributed  or  imputed  to  the  services  of  capital, 
as  distinct  from  the  services  of  land  and  labor.  Interest  is  usu- 
ally measured  as  a  percentage  of  the  money  value  of  capital,  and 
this,  coupled  with  the  fact  that  capital  is  often  lent  in  the  form 
of  money,  has  led  to  the  prevalence  of  the  idea  that  interest  is  a 
payment  for  the  use  of  money.  This  is  only  a  partial  descrip- 
tion of  interest,  however,  for  it  does  not  include  imputed  interest 
nor  the  loan  interest  paid  in  the  form  of  rentals  for  the  use  of 
many  forms  of  capital  —  buildings,  for  example. 

Objections  to  Interest  Taking.  —  It  is  only  in  modern  times  that  interest 
has  been  generally  considered  a  legitimate  and  necessary  form  of  income. 
The  strong  denunciations  of  usury  contained  in  both  the  Old  and  New  Testa- 
ments are  denunciations  of  interest  taking,  for  the  word  "usury"  formerly 
meant  any  kind  of  interest,  and  not  merely  excessive  interest,  as  at  present. 
The  opinion  of  many  classical  writers  is  illustrated  by  Aristotle's  dictum  that 
"  money  was  intended  to  be  used  in  exchange,  but  not  to  increase  at  interest." 
,fDuring  the  greater  part  of  the  middle  ages  the  authority  and  teaching  of  the 
church  was  set  definitely  against  the  taking  of  interest  in  any  form.  In  the 
middle  of  the  fourteenth  century  the  prohibition  of  usury  was  incorporated 
in  the  civil  law.  These  objections,  however,  had  reference  chiefly  to  loan 
interest,  and  interest  on  money  lent  for  personal  use  at  that ;  for  capital  was 
not  thought  of  as  one  of  the  factors  in  production  until  comparatively  modern 
times.  In  fact,  by  the  fifteenth  century,  when  opportunities  for  the  profitable 
use  of  money  had  appeared  in  such  forms  as  the  purchase  of  rights  to  receive 
land  rents,  or  partnership  ventures  in  trade  (where  interest  was  held  to  be 
justified  by  the  risk  incurred),  the  canonists  (the  writers  on  church  law) 
admitted  the  legitimacy  not  only  of  such 'gainful  employments  of  money, 

493 


494  OUTLINES   OF   ECONOMICS 

but  also,  in  many  cases,  of  interest  on  loans.  The  justification  of  loan  inter- 
est took  on  at  first  many  curious  forms.  It  was  regarded  in  some  cases  as 
a  fine  for  delay  in  the  repayment  of  the  loan,  so  that  lenders  often  resorted 
to  the  subterfuge  of  lending  money  gratuitously  for  a  nominal  period,  the 
real  agreement  being  that  they  were  to  get  back  their  money  principal,  with 
a  fine  for  the  delay  added,  at  a  later  date.  In  other  cases  loan  interest  was 
justified  as  a  payment  for  the  loss  of  the  possible  gains  which  the  lender 
might  have  got  by  using  his  money  himself.  Usury,  which  at  first  meant  any 
kind  of  loan  interest,  came  to  mean  interest  on  money  loans  to  relieve  per- 
sonal needs,  rather  than  for  gainful  employment,  then  interest  on  loans  in 
which  the  element  of  risk  was  lacking,  and  finally,  excessively  high  interest. 
Today  the  use  of  capital  is  so  prominent  a  feature  of  our  productive  meth- 
ods that  the  legitimacy  of  interest  is  not  generally  questioned.  Socialistic 
writers,  however,  insist  that  interest  is  only  a  result  of  the  system  of  the  pri- 
vate ownership  of  capital,  and  that  with  the  abolition  of  private  property  in 
production  goods  what  is  now  counted  as  interest  would  become  part  of  the 
wages  of  labor.  It  is  accordingly  important  that  we  should  understand 
clearly  why  interest  has  to  be  paid,  as  well  as  that  we  should  study  the  factors 
determining  the  rate  of  interest.  We  shall  find,  however,  that  the  explana- 
tion of  the  necessity  of  interest  is  really  a  part  of  the  explanation  of  the  rate 
of  interest. 

Inadequate  Explanations  of  Interest.  — An  idea  that  naturally 
suggests  itself  is  that  interest  has  to  be  paid  for  the  use  of  money 
because  "  money  can  be  profitably  employed  in  business."  But 
this  is  only  an  attempt  to  explain  loan  interest  by  assuming  the 
existence  of  imputed  interest.  What  we  want  to  know  is  why 
"  money  can  be  profitably  employed  in  business." 

A  similar,  but  somewhat  more  definite,  attempt  at  an  explana- 
tion is  contained  in  the  statement  that  interest  is  paid  because 
capital  is  productive.  It  is  pointed  out  that  by  the  use  of  capital 
goods  the  product  of  industry  is  greatly  increased  over  what 
could  be  produced  by  labor  and  land  alone.  This  is,  of  course, 
true,  but  taken  alone  it  does  not  explain  interest.  The  problem 
of  interest  relates  to  the  value  of  the  product,  not  to  the  amount 
of  the  product.  There  is  nothing  in  the  mere  quantity  of  the 
product,  taken  by  itself,  that  gives  value  to  it.  Farmers  have 
found  more  than  once  that  a  large  wheat  crop  has  sold  for  less 
in  the  aggregate  than  a  small  one.  The  real  problem  of  in- 
terest is  this :  How  can  an  entrepreneur,  by  the  use  of  capital, 
increase  the  selling  value  of  his  product  enough  to  not  only  pay 


INTEREST  495 

for  the  capital  actually  used  up  in  production,  but  also  to  pay  in 
addition  a  surplus  in  the  form  of  interest  upon  the  capital  em- 
ployed? Nor  can  we  say  that  "capital  produces  interest." 
It  cannot  be  too  strongly  emphasized  that  neither  land,  nor  labor, 
nor  capital  produces  value.  They  are  simply  the  instruments 
used  in  the  production  of  things  that  command  a  price  in  the 
market  because  they  satisfy  human  wants  and  will  not  be  fur- 
nished except  at  a  price.  Part  of  the  value  of  the  product  is 
imputed  or  attributed  to  capital  in  the  form  of  interest,  and  it 
is  because  of  its  capacity  to  earn  interest  that  capital  is  valued. 
To  say  that  capital  produces  value  is  to  reverse  the  true  process. 
Capital  goods  produce  (or  aid  in  the  production  of)  other  goods, 
and  the  selling  value  of  these  produced  goods  is  the  cause  of 
capital  value. 

Why  Interest  can  be  Paid.  —  We  shall  find  the  analysis  of  our 
problem  somewhat  simpler  if  we  divide  it  into  two  parts :  first, 
why  interest  is  possible;  and  second,  why  interest  must  be  paid. 
In  discussing  why  interest  can  be  paid,  we  shall  assume  that  in- 
terest must  be  paid  if  capital  is  to  be  used  in  production,  reserv- 
ing the  discussion  of  the  legitimacy  of  this  assumption  for  the 
following  section. 

It  is  the  physical  productivity  of  capital  —  the  fact  that 
capital  can  be  used  in  cooperation  with  land  and  labor  in  the 
production  of  goods  —  that  makes  it  possible  for  the  entre- 
preneur to  look  upon  part  of  his  total  money  income  as  interest 
on  his  investment  of  capital.  Now,  as  we  have  seen,  the  mere 
fact  that  capital  is  productive  in  the  physical  sense  does  not 
explain  interest,  but  the  fact  that  capital  is  used  under  the  guid- 
ance of  entrepreneurs  in  the  production  of  goods  does  explain  the 
possibility  of  interest.  The  mere  physical  productivity  of  land 
does  not  explain  rent  —  land  will  grow  weeds  as  well  as  wheat ; 
nor  does  the  mere  physical  productivity  of  labor  explain  wages 
—  some  men  have  put  years  into  the  construction  of  perpetual- 
motion  machines  that  are  absolutely  worthless.  But  it  is  the 
business  of  the  entrepreneur  to  see  that  land  and  labor  are  used 
wisely ;  and  from  his  point  of  view  they  are  used  wisely  if  they 
are  used  in  the  production  of  things  that  consumers  want,  and 


496  OUTLINES   OF   ECONOMICS 

want  intensely  enough  to  pay  such  prices  as  will  enable  the 
entrepreneur  to  pay  the  rent  of  the  land  and  the  wages  of  the 
labor  employed.  Similarly,  an  entrepreneur  will  not  employ 
capital  in  any  kind  of  production  unless  the  prices  he  expects  to 
get  for  his  products  are  such  as  to  cover  the  expenses  incurred 
in  the  use  of  capital.  Nor  will  he  knowingly  use  so  much  capital 
that  his  product  will  sell  for  less  than  a  smaller  product  would 
have  sold  for,  any  more  than  he  will  knowingly  produce  an  un- 
profitably  large  quantity  of  goods  by  the  use  of  too  much  labor 
or  too  much  land. 

On  the  one  hand,  the  entrepreneur  has  to  estimate  the  prices  he 
will  get  for  his  products ;  on  the  other  hand,  he  has  to  estimate 
the  productivity  and  the  expense  of  land,  labor,  and  capital. 
The  expense  of  capital  includes,  first,  the  cost  of  the  capital 
actually  used  up  in  production ;  and  second,  interest  on  all  of 
the  capital  used,  whether  "  used  up  "  or  not  (assuming,  as  previ- 
ously explained,  the  necessity  of  interest).  The  principles  that 
will  guide  the  entrepreneur  as  to  the  relative  proportions  of  labor, 
land,  and  capital  he  will  use  have  already  been  discussed  in 
connection  with  the  general  subject  of  diminishing  productivity. 
We  may,  however,  emphasize  again  the  fact  that  productivity 
must  be  attributed,  not  to  "  capital  in  general,"  but  to  specific 
units  of  specific  kinds  of  capital,  used  in  connection  with  definite 
amounts  of  land  and  labor;  the  productivity  imputed  to  any 
particular  unit  of  capital  being  the  precise  amount  of  product 
actually  dependent  upon  the  use  of  that  particular  unit  —  the 
amount  by  which  the  total  product  would  be  decreased  if  the 
unit  in  question  were  not  used.  An  entrepreneur  will  increase 
his  use  of  capital  rather  than  of  labor  or  land,  when  a  given 
expense  for  any  kind  of  capital  will  add  more  to  his  product 
than  would  a  similar  expense  for  labor  or  land. 

The  Necessity  of  Interest.  —  Free  goods,  such  as  air  or  the 
force  of  gravitation,  are  productive  in  the  physical  sense,  in 
that  they  are  absolutely  necessary  to  most  forms  of  production. 
The  surface  of  Lake  Michigan  is  used  in  producing  the  service 
of  transportation  in  essentially  the  same  way  as  is  capital  in  the 
form  of  a  railway  roadbed  and  track.     But  we  cannot  impute 


INTEREST  497 

productivity  to  specific  units  of  free  goods,  for  the  simple  reason 
that  the  amount  of  the  product  is  not  dependent  on  the  utiliza- 
tion of  any  one  unit  of  them.  Any  one  cubic  foot  of  air  could  be 
dispensed  with ;  we  cannot  even  conceive  of  the  force  of  gravita- 
tion as  limited  in  quantity ;  the  Great  Lakes  furnish  pathways 
that  are  more  than  sufficient  for  all  the  vessels  that  traverse 
them.  We  do  impute  productivity  to  the  better  lands  that  are 
used  in  production,  because  any  one  acre  of  them  could  not  be 
withdrawn  from  use  without  a  diminution  in  the  product. 
The  controlling  reason  for  this  difference  is  that  the  spontaneous 
supply  of  free  goods  is  in  excess  of  the  use  that  is  made  of  them ; 
while  the  supply  of  the  better  lands  is  limited  as  compared  with 
the  demand  for  them.  This  suggests  at  once  why  productivity 
has  to  be  imputed  to  specific  units  of  capital,  and  that  is,  that 
the  supply  of  capital  is  limited. 

Why  is  the  supply  of  capital  limited  ?  This  question  leads  us 
to  examine  the  nature  of  the  supply  of  capital.  Imagine  a 
society  without  capital  carrying  on  its  productive  processes  by 
the  use  of  labor  and  land  only.  So  long  as  the  members  of  this 
community  produce  only  what  they  consume  directly,  or  (if, 
despite  the  absence  of  capital,  money  economy  and  a  system  of 
exchange  may  be  imagined  to  prevail)  so  long  as  they  spend  all 
their  money  incomes  for  things  used  up  immediately  in  the  satis- 
faction of  their  wants,  there  will  be  no  accumulation  of  capital. 
In  order  that  capital  shall  be  furnished,  it  is  necessary  that  some 
members  of  the  community  turn  aside  from  the  production  of 
things  that  are  used  in  the  immediate  satisfaction  of  their  wants 
and  devote  their  time  to  the  production  of  goods  that  will  be 
used  in  further  production.  Whether  they  do  this  on  their  own 
account,  or  whether  they  are  paid  for  their  work  while  they  are 
doing  it  by  others,  some  postponement  of  the  satisfaction  of 
wants  is  necessary.  In  the  one  case  those  who  produce  the 
capital  goods  give  up  temporarily  the  satisfactions  which  they 
would  have  derived  from  the  consumption  goods  they  might 
have  produced.  In  the  other  case,  those  who  are  devoting  part 
of  their  money  incomes  to  the  payment  of  those  who  are  pro- 
ducing capital  goods  are  giving  up  the  immediate  satisfactions 


498  OUTLINES  OF   ECONOMICS 

which  they  might  have  secured  with  the  money.  In  either  case 
the  production  of  capital  involves  the  sacrifice  of  waiting  on  the 
part  of  some  members  of  the  community. 

But  why  should  waiting  be  called  a  sacrifice?  Do  not  those 
who  give  up  present  satisfactions  in  order  that  capital  goods 
may  be  produced  get  a  full  repayment  if  they  get  back  in  the 
form  of  the  products  of  their  capital  goods  as  much  as  they,  for 
the  time  being,  give  up?  In  other  words,  why  should  capital 
not  be  furnished  for  productive  purposes  if  those  who  furnish  the 
capital  get  back  an  exact  equivalent  (in  price)  for  the  amount  of 
capital  they  have  supplied  ?  Why  should  an  extra  payment,  in 
the  form  of  interest,  be  necessary  to  induce  saving? 

The  answer  to  these  questions  is  found  in  the  difference  between 
our  present  appraisals  of  things  to  be  had  now  and  things  to  be 
had  in  the  future.  We  visualize  the  present  more  vividly  than 
we  do  the  future ;  we  yield  sometimes  to  the  temptation  of  satis- 
fying the  more  trivial  wants  of  the  present,  even  when  we  know 
that  we  are  thereby  rendering  uncertain  the  satisfaction  of  more 
important  wants  in  the  future ;  and  when  we  take  considerable 
periods  of  time  into  account,  we  may  reasonably  say  that  the 
uncertainty  of  life  itself  gives  us  some  ground  for  preferring 
present  to  possible  future  satisfactions.  Notwithstanding  the 
vast  difference  between  civilized  men  and  savages  in  this  respect 
—  for  many  of  the  latter  seem  to  have  absolutely  no  regard  for 
future  needs  —  the  fact  still  remains  that  waiting  is  a  sacrifice, 
and  in  order  to  induce  the  saving  that  is  a  prerequisite  to  the 
use  of  capital  in  industry,  a  premium  or  reward  for  waiting  has 
to  be  paid  in  the  form  of  interest.  This  fact  is  the  most  funda- 
mental thing  in  the  explanation  of  interest. 

It  must  not  be  inferred  that,  in  the  actual  economic  life  of  to- 
day, no  capital  would  be  supplied  if  interest  were  not  paid. 
There  are  other  motives  that  induce  men  to  save  parts  of  their 
incomes.  The  desire  to  provide  for  old  age  and  for  such  con- 
tingencies as  sickness  and  accident,  or  to  make  provision  for 
one's  family  in  case  of  death,  would  result  in  a  considerable 
amount  of  saving.  The  mere  pride  of  accumulation,  and  the 
fact  that  the  satisfaction  of  many  important  wants,  such  as  the 


INTEREST  49Q 

desire  to  own  a  house,  or  the  desire  for  foreign  travel,  necessitate 
the  gradual  accumulation  of  what  is  to  most  persons  a  consider- 
able sum  of  money,  must  also  be  given  due  weight.  Moreover, 
none  of  these  motives  would  in  itself  induce  men  to  invest  or 
lend  their  saved  funds  in  productive  undertakings  if  no  interest 
at  all  were  paid.  In  fact,  this  would  be  a  matter  of  indifference, 
for  savings  might  just  as  well  be  hoarded.  But  a  very  low 
interest  premium  would  suffice  to  overcome  this  indifference  and 
to  bring  about  their  investment  in  productive  undertakings. 
Even  this  low  interest  rate,  however,  would  be  sufficient  to 
balance,  in  some  additional  cases,  the  difference  between  the 
intensity  of  present  wants  and  the  intensity  of  future  wants, 
so  that  in  these  cases,  in  turn,  spending  or  saving  would  be  a 
matter  of  indifference  —  an  indifference  that  would  in  its  turn 
be  overcome  by  a  slight  increase  in  the  interest  rate.  In  a 
similar  way  every  increase  in  the  interest  rate  would  induce 
more  persons  to  save  and  would  induce  many  of  those  who  were 
already  saving  a  part  of  their  incomes  to  save  a  larger  propor- 
tion of  them. 

At  any  given  time,  accordingly,  the  interest  rate  is  consider- 
ably higher  than  is  necessary  to  secure  a  large  part  of  the  waiting 
that  devolves  upon  those  who  furnish  capital  funds  for  pro- 
ductive purposes.  It  is  just  high  enough,  however,  to  be  a 
recompense  for  marginal  waiting,  which  is  the  waiting  that 
would  not  take  place  if  the  interest  rate  were  any  lower.  If 
the  interest  rate  is  5  per  cent,  a  dollar  today  is  worth  a  dollar 
and  five  cents  a  year  from  today,  not  to  all  savers,  but  to  the 
marginal  savers. 

Investment.  —  We  have  seen  that  the  supply  of  capital 
originates  in  the  fact  that  some  people  save  part  of  their  money 
incomes,  and  that  interest  has  to  be  paid  in  order  to  induce  this 
saving.  Such  persons  are  said  to  get  an  "  income  from  their 
capital."  Strictly  speaking,  their  savings  are  not  productive 
capital  at  all,  in  the  sense  in  which  the  word  "  productive  "  is 
used  in  this  book.  Productive  capital  consists  of  the  concrete 
material  instruments  of  production,  such  as  factory  buildings, 
machines,  raw  materials,  merchants'  stocks  of  finished  products, 


5<DO  OUTLINES  OF  ECONOMICS 

and  the  like.  Savings  are  not  productive  capital  in  this  sense, 
but  the  process  by  which  they  are  transmuted  into  productive 
capital  is  a  simple  and  familiar  one.  The  simplest  case  is  where 
the  entrepreneur  saves  part  of  his  own  money  income  and  uses 
his  savings  in  the  purchase  of  additional  capital  goods,  the  selling 
value  of  the  products  of  which  he  estimates  will  be  large  enough 
to  repay  him  for  his  waiting,  as  well  as  to  replace  his  capital  as  it 
is  used  up,  that  is,  to  earn  interest  for  him  as  well  as  repay  the 
principal.  Or,  the  entrepreneur  may  borrow  money  directly 
from  others  who  have  saved  it,  agreeing  to  pay  annual  interest, 
and  in  addition  to  repay  the  amount  of  the  loan  —  the  principal 
—  at  some  specified  time.  In  the  complex  economy  of  the  pres- 
ent, however,  it  very  often  happens  that  the  entrepreneur  who 
can  use  money  profitably  and  the  man  who  has  surplus  funds  to 
invest  do  not  arrange  the  transaction  directly.  Savings  are 
"  placed  at  interest  "  in  savings  banks,  insurance  companies,  or 
other  financial  institutions,  and  it  is  to  such  institutions  that  the 
entrepreneur  who  thinks  that  he  can  use  more  capital  profit- 
ably applies  for  loans. 

Very  often  the  entrepreneur  is  a  corporation  rather  than  an 
individual,  but  the  same  three  methods  of  obtaining  capital  are 
open  to  it.  The  corporation  may  choose  to  reinvest  some  of  its 
net  earnings  in  productive  forms  of  capital  rather  than  to  pay 
them  all  out  in  dividends  to  its  stockholders.  When  in  need  of 
money  to  meet  a  temporary  emergency,  the  corporation  may 
borrow  from  banks  just  as  the  individual  entrepreneur  does. 
When  in  need  of  money  for  more  permanent  investment  in  the 
durable  forms  of  capital  goods,  the  corporation  usually  issues  its 
own  interest-bearing  obligations  in  the  form  of  bonds,  which  it 
sells  to  banks,  insurance  companies,  and  other  financial  institu- 
tions, as  well  as  to  individuals.  Bond  issues  are  merely  one  way 
of  borrowing  money.  But  whether  the  money  funds  are  fur- 
nished by  the  entrepreneur  or  by  others,  the  formation  of  capital 
necessitates,  first,  the  saving  of  parts  of  money  incomes,  and 
second,  the  use  of  the  funds  thus  secured  in  the  purchase  of 
capital  goods.  The  expression  "  investment  of  money  "  is  used 
as  a  short  way  of  describing  this  twofold  process. 


INTEREST  501 

The  Replacement  of  Capital.  —  It  is  clear,  then,  that  saving 
which  necessitates  waiting,  is  a  prerequisite  to  the  formation  of 
new  capital,  that  is,  to  an  increase  of  the  supply  of  capital  already 
in  existence.  But  at  any  given  time  the  capital  already  in  exist- 
ence forms  a  very  large  proportion  of  the  total  supply  of  capital, 
and  it  may  be  thought  that  the  present  interest  rate  does  not 
affect  this  portion  of  the  supply.  We  must,  however,  take  into 
consideration  the  fact  that  almost  all  kinds  of  capital  are  being 
continually  used  up  in  production.  This  using  up  may  be  a 
matter  of  a  single  use,  as  in  the  case  of  fuel  or  raw  materials,  or  it 
may  be  a  gradual  wearing  out,  as  in  the  case  of  a  machine,  but 
such  differences  are  differences  in  degree  of  durability  rather 
than  differences  in  kind. 

As  we  have  seen,  the  entrepreneur  will  normally  not  employ 
any  given  additional  unit  of  capital  unless  he  expects  to  get 
enough  from  the  selling  value  of  the  added  product  to  replace 
the  capital  actually  used  up  in  production  as  well  as  to  pay 
interest.  This  means  that  if  the  entrepreneur's  estimates  prove 
correct,  part  of  the  money  income  he  gets  for  his  product  may 
be  regarded  as  a  replacement  fund,  sufficient  in  amount  to  replace 
the  capital  used  up  in  production. 

We  must  not,  however,  make  the  error  of  thinking  of  the 
replacement  fund  as  definite  in  quantity.  Whether  or  not  any 
unit  of  capital  produces  enough  to  furnish  a  replacement  fund, 
depends  on  whether  the  entrepreneur's  estimate  is  a  correct  one. 
There  is  no  reason  why  unproductive  forms  of  capital  should  be 
kept  intart  in  amount.  He  would  be  a  foolish  business  man,  for 
instance,  who  would  keep  reinvesting  a  certain  amount  of  money 
in  raw  materials  in  the  face  of  a  diminishing  demand  for  the  fin- 
ished product.  Even  if  enough  income  is  earned  to  form  a  re- 
placement fund,  the  capital  used  up  need  not  be  replaced  unless 
the  entrepreneur  so  chooses.  A  farmer  may  have  saved  for 
years  in  order  to  buy  a  reaper.  The  reaper  will  enable  him  to 
raise  more  wheat,  or,  possibly,  to  produce  the  same  amount  of 
wheat  at  less  expense.  In  either  case  it  will  mean  an  increase 
in  his  net  money  income.  He  may,  if  he  chooses,  set  aside  enough 
of  this  added  income  so  that,  when  the  first  reaper  wears  out,  his 


502  OUTLINES  OF  ECONOMICS 

accumulated  funds  will  replace  it.  From  one  point  of  view  we 
may  say  that  in  this  way  the  reaper  "  replaces  itself."  But  the 
farmer  may,  if  he  prefers,  use  all  of  his  increased  income  in  the 
purchase  of  additional  comforts  and  luxuries  for  himself  and  his 
family.  In  deciding  whether  he  will  replace  his  capital  or  in- 
crease his  present  consumption,  he  will  be  guided  by  the  same 
kind  of  an  estimate  of  the  relative  importance  of  present  and 
future  wants  on  the  one  hand,  and  of  the  amount  which  the 
capital  will  add  to  his  income,  on  the  other  hand,  that  guided 
him  in  the  original  saving  which  led  to  the  purchase  of  the  first 
reaper. 

Similar  illustrations  can  be  found  in  other  kinds  of  undertak- 
ings. Many  business  enterprises  have  failed  because  business 
men  have  "  lived  beyond  their  incomes  "  —  which  often  means 
simply  that  they  have  not  replaced  their  capital  so  rapidly  as 
they  have  used  it  up.  Many  American  railways  have  main- 
tained a  specious  prosperity  for  many  years  by  paying  "  un- 
earned dividends  " ;  that  is,  by  letting  their  capital  (roadbed, 
rolling  stock,  buildings,  etc.)  deteriorate  through  not  expending 
enough  of  their  gross  income  in  the  maintenance  of  their  way 
and  equipment. 

The  stock  of  capital  in  existence  at  any  one  time  is  the  result  of 
past  saving.  But  this  stock  of  capital  cannot  be  maintained  intact 
without  more  saving.  From  this  point  of  view  we  may  say  that 
the  sacrifice  of  present  satisfactions  for  future  satisfactions 
which  society  undergoes  in  order  to  reap  the  advantages  of 
capitalistic  production  is  not  something  that  is  done  "  once  for 
all,"  but  is  a  continuous  sacrifice. 

The  Shifting  of  Investment.  —  As  a  matter  of  fact,  a  large 
amount  of  the  capital  that  is  used  up  in  production  is  not  re- 
placed, for  the  simple  reason  that  entrepreneurs  find  that  some 
particular  kinds  of  capital  are  not  profitable ;  that  is,  they  do 
not  add  enough  to  the  selling  value  of  the  entrepreneur's  total 
product  to  repay  them  for  their  cost  (including  interest  and 
repayment  of  principal).  It  may  happen  that  the  entrepreneur 
has  been  mistaken  as  to  the  technical  efficiency  (or  productivity) 
of  his  capital,  or  that  he  has  overestimated  the  demand  for  his 


INTEREST  503 

products.  New  inventions  or  new  methods  of  production  may 
lessen  the  income-yielding  power  of  part  of  the  existing  stock  of 
capital,  or  capricious  changes  in  demand  may  have  a  similar 
effect.  At  the  same  time,  these  new  methods  of  production  and 
these  changes  in  demand  are  making  new  forms  of  capital  prof- 
itable. Even  if  the  "  replacement  fund  "  were  a  definite  and 
rigid  annual  sum,  it  would  not  be  entirely  devoted  to  replacing 
the  particular  kinds  of  capital  that  had  been  used  up  in  produc- 
tion. There  would  be  a  continual  shifting  from  the  less  prof- 
itable to  the  more  profitable  forms  of  capital. 

We  often  hear  it  said  that  capital  is  transferred  from  one  indus- 
try to  another,  or  from  one  locality  to  another,  or  from  one 
country  to  another.  Such  expressions  are  misleading.  Capital 
goods  are  not  usually  transferred  in  this  fashion,  although  in 
exceptional  cases  it  may  happen.1  These  statements  often 
mean  that  the  ownership  of  capital  changes,  as  when  a  capitalist 
sells  his  holdings  in  one  industry  to  another  capitalist  and  invests 
his  own  funds  in  another  undertaking.  The  most  important 
way  in  which  "  capital  is  transferred  "  is  through  that  gradual 
process  of  shifting  in  the  forms  of  investment  which  has  just 
been  described. 

The  Relation  of  the  Durability  of  Capital  Goods  to  Invest- 
ment. —  The  ease  with  which  investments  may  be  shifted 
varies  for  different  forms  of  capital.  Especially  important  in  this 
connection  is  the  durability  of  capital.  As  has  been  already 
suggested,  some  forms  of  capital  are  destroyed  as  capital  by  a 
single  use.  The  fuel  and  raw  materials  used  in  a  manufacturing 
establishment  and  the  merchant's  stock  in  trade  belong  to  this 
category.  The  merchant's  stock  in  trade  becomes  consump- 
tion goods  in  the  hands  of  consumers ;  raw  materials  reappear 
in  the  finished  product,  as  do  other  forms  of  capital  for  that 
matter,  although  in  a  less  obvious  sense.  But  the  fact  remains 
that  these  particular  forms  of  capital  investments  yield  their 
services  only  once,  and  when  they  are  once  used  by  the  entre- 

1  For  example,  some  generally  used  kinds  of  machinery  (such  as  lathes,  milling 
or  planing  machines,  engines,  or  motors)  may  be  transferred  from  one  establishment 
in  one  industry  to  an  establishment  in  another  industry. 


504  OUTLINES   OF  ECONOMICS 

preneur  for  the  purpose  for  which  they  were  intended,  they 
cease  to  be  capital,  even  though  they  may  have  successors  in 
new  forms  of  capital. 

From  such  transient  forms  of  capital  we  may  pass  by  insensible 
gradations  to  capital  goods  which  yield  a  long  succession  of  serv- 
ices, the  series  culminating  in  such  durable  forms  of  capital  as 
buildings  used  for  productive  purposes,  or  railway  roadbeds.  If 
a  particular  form  of  capital  lasts  for  exactly  a  year  —  the  period 
of  time  usually  taken  as  a  unit  in  the  computation  of  the  rate 
of  interest  —  estimating  the  expense  of  employing  such  capital 
is  a  very  simple  matter.  If,  for  example,  the  rate  of  interest 
which  an  entrepreneur  sets  as  his  minimum  is  6  per  cent,  he  will 
not  invest  $1000  in  such  capital  unless  he  estimates  that  it  will 
increase  his  product  by  an  amount  that  will  sell  for  at  least 
$1060. 

In  the  case  of  the  more  transient  forms  of  capital,  however,  the 
computation  is  usually  made  by  taking  into  account  the  "  rate 
of  turnover."  A  manufacturer  may  be  constantly  buying  raw 
materials  and  making  them  into  finished  products.  If  the  raw 
materials  purchased  during  a  year  cost  $3000,  but  if,  on  the 
average,  only  $1000  is  invested  in  raw  materials  at  any  one 
time,  the  capital  is  said  to  be  "  turned  over  "  three  times  during 
the  course  of  the  year.  The  interest  rate  is  computed  only  on 
the  average  amount  of  capital  "  tied  up,"  so  that  interest  of  2 
per  cent  on  each  turnover  would  amount  to  6  per  cent  on  the 
actual  investment  of  money. 

In  the  case  of  the  more  durable  forms  of  capital  the  computa- 
tion is  more  complicated.  Here  the  entrepreneur  has  to  take 
into  account  not  only  the  original  expense  of  the  capital  good  and 
the  amounts  which  it  will  add  to  his  annual  product,  but  also  its 
durability,  and  the  fact  that  a  large  part  of  the  income  which  it 
will  earn  for  him  is  future  income.  This  future  income,  as  we 
have  seen,  will  not  be  appraised  so  highly  as  the  same  amount  of 
present  income  would  be. 

The  Expense  and  Price  of  Capital.  —  When  we  speak  of  the 
cost  or  expense  of  capital,  we  may  have  in  mind  either  one  of 
two  distinct  things.     We  may  mean  (1)  the  price  paid  by  the 


INTEREST  505 

entrepreneur  for  the  loan  of  the  money  funds  which  he  invests 
in  specific  kinds  of  capital  goods,  or  we  may  mean  (2)  the  prices 
paid  for  the  capital  goods  themselves.  The  first  thing  .is,  of 
coarse,  loan  interest ;  the  second  is  simply  a  matter  of  the 
market  prices  of  commodities.  It  is  this  second  thing  —  the 
market  price  of  capital  goods  —  that  we  wish  to  consider  at 
this  point.  As  commodities,  these  capital  goods  come  under 
the  general  laws  of  value  and  price,  and  most  of  what  has 
been  said  in  earlier  chapters  about  the  valuation  of  consump- 
tion goods  holds  just  as  true  in  respect  to  the  valuation  of 
these  production  goods.  Their  price  at  any  given  time  is 
apt  to  be  fixed  rather  close  to  the  point  where  demand  and 
supply  would  be  in  equilibrium.  In  the  long  run  their  values  — 
if  they  are  not  patented  products,  but  are  competitively  pro- 
duced —  cannot  get  very  far  away  from  the  expenses  of  produc- 
ing them. 

But  there  is  one  fundamental  difference  which  has  been  sug- 
gested in  other  connections.  Consumption  goods  are  valued 
because  they  satisfy  human  wants,  and  the  intensity  of  the 
wants  which  particular  units  of  goods  satisfy  have,  through 
the  principle  of  marginal  utility,  a  very  direct  relation  to  their 
market  values.  Capital  goods  do  not  satisfy  human  wants 
directly ;  they  command  a  price  simply  because  they  aid  in 
the  production  of  goods  that  do  satisfy  human  wants  directly. 
The  demand  for  them,  as  we  have  seen,  is  the  entrepreneur's 
interpretation  of  the  demand  for  their  products.  The  law  of 
diminishing  productivity  bears  about  the  same  relation  to  the 
determination  of  their  values  that  the  law  of  diminishing 
utility  does  to  the  determination  of  the  values  of  consumption 
goods. 

As  in  the  case  of  the  demand  for  labor,  the  elasticity  of  the 
demand  for  a  particular  sort  of  capital  goods  is  affected  not 
only  (1)  by  the  fact  that  the  higher  the  price  of  the  capital, 
the  higher  will  have  to  be  the  price  of  the  product,  and,  conse- 
quently, the  smaller  will  be  the  quantity  of  the  product  that 
can  be  sold,  but  also  (2)  by  the  fact  that  when  the  price  of  any 
variety  of  capital  goods  is  relatively  high,  the  entrepreneurs 


506  OUTLINES  OF  ECONOMICS 

will  economize  in  the  use  of  that  particular  kind  of  capital  and 
will  use  relatively  more  labor,  relatively  more  land,  and  rela- 
tively more  of  the  other  forms  of  capital.  The  first  of  these 
facts  is  a  corollary  of  the  law  of  diminishing  utility ;  the  second, 
a  corollary  of  the  law  of  diminishing  productivity. 

This  analysis  of  the  price  of  capital  goods  relates,  however, 
only  to  the  supply  of  new  capital  goods.  After  capital  goods 
are  once  definitely  installed  in  industrial  uses,  its  selling  value 
is  determined  solely  by  its  ability  to  earn  an  income  for  its 
owner.  If  the  entrepreneur  has  overestimated  the  technical 
efficiency  of  a  machine  or  the  salability  of  its  products,  that  is, 
if  he  has  overestimated  its  income-yielding  power,  he  may  find 
that  its  money  value  to  him  is  less  than  the  price  he  paid  for  it. 
Here,  however,  we  have  to  note  an  important  distinction  be- 
tween free  capital  and  specialized  capital. 

Free  and  Specialized  Capital.  —  By  free  capital  we  mean 
capital  that  has  a  number  of  different  possible  uses,  or  that  can 
be  transferred  from  one  industry  or  one  establishment  to  an- 
other. Specialized  capital  is  capital  that  can  be  used  for  only 
one  purpose,  and  that  cannot  be  transferred  from  one  estab- 
lishment or  industry  to  another.  The  capital  invested  in  the 
construction  of  a  railway  roadbed,  or  in  the  digging  of  an  irri- 
gation ditch,  is  absolutely  specialized.  The  roadbed  and  the 
irrigation  ditch  are  of  use  only  in  connection  with  the  particular 
transportation  or  agricultural  undertakings  for  which  they  were 
constructed.  If  the  undertakings  should  fail,  the  value  of  these 
specialized  forms  of  capital  would  be  absolutely  wiped  out.  A 
manufacturing  firm  may  invest  a  large  amount  of  money  in 
new  models  of  specially  designed  machinery.  If  the  new 
machines  prove  unsuccessful,  their  value  may  sink  to  what  they 
will  sell  for  as  scrap  iron. 

Free  capital  is  found  in  such  forms  as  tools,  machines  of  the 
standard  models  that  are  used  in  different  establishments  in 
the  same  industry,  or  even  in  different  industries ;  raw  materials 
that  can  be  made  up  into  different  kinds  of  finished  products 
and  the  like.  A  farmer  who  stocks  his  farm  with  dairy  cattle, 
but  finds  his  land  unsuited  for  a  dairy  farm,  does  not  incur  a 


INTEREST  507 

total  loss  on  his  investment,  for  he  can  sell  his  cattle  to  some 
farmer  who  can  make  profitable  use  of  them. 

The  distinction  here  emphasized  is  only  one  of  degree.  We 
have  capital  in  a  considerable  variety  of  forms  that  are  partly 
free  and  partly  specialized.  Such  capital  is  capital  that  is  best 
adapted  to  one  specific  purpose,  but  which  may  also  be  put  to 
other  uses.  One  frequently  sees  buildings,  originally  erected  for 
office  purposes  on  a  badly  chosen  site,  that  have  been  give  over 
to  small  manufacturing  concerns.  A  building  intended  for  a 
factory  may  serve  fairly  well  as  a  warehouse. 

The  importance  of  these  distinctions  lies  in  the  fact  that  the 
possibility  of  alternative  uses  forms  a  barrier  to  the  deprecia- 
tion of  the  selling  value  of  such  free  capital  as  is  found  to  yield 
less  income  in  some  particular  use  than  was  expected  by  the 
entrepreneur.  If  such  goods  can  yield  a  larger  income  in  some 
other  use,  they  can  be  transferred  (through  a  change  in  the 
nature  of  the  entrepreneur's  business  or  through  sale  or  lease  to 
other  entrepreneurs)  to  this  more  profitable  use.  Such  trans- 
fers are  continually  taking  place  in  actual  business. 

Capital  and  Land.  —  The  analysis  of  the  process  by  which 
capital  goods  are  priced  opens  the  way  for  a  consideration  of  a 
problem  that  has  been  suggested  in  earlier  pages,  —  the  rea- 
son for  the  economic  distinction  between  capital  and  land. 
Some  points  of  similarity  are  obvious :  land  and  capital  are 
both  valued  according  to  their  income-yielding  power.  The 
selling  value  of  land,  like  the  selling  value  of  capital,  is  based  in 
large  measure  on  the  capitalization  of  the  prospective  income 
to  be  derived  from  it.  From  the  point  of  view  of  the  individ- 
ual investor,  the  purchase  of  land  for  productive  purposes  is  an 
investment  of  money  just  as  truly  as  is  the  purchase  of  capital 
goods. 

Yet  there  are  equally  obvious  differences :  land  is  given  by 
nature ;  capital  is  "  man-made."  The  amount  of  land  is 
limited  —  a  statement  that  holds  true  whether  we  have  in 
mind  the  land  actually  available  for  productive  uses  under 
existing  conditions,  or  whether  we  have  in  mind  the  whole 
surface  of  the  earth.    The  supply  of  capital,  on  the  other  hand, 


.$o8  OUTLINES  OF   ECONOMICS 

is  capable  of  indefinite  extension.  It  may  be  said,  of  course, 
that  an  extension  of  transport  facilities,  by  which  the  available 
supply  of  land  is  increased,  is  a  "  production  of  land."  This 
is,  however,  only  a  figurative  use  of  the  word  "  production." 
In  this  figurative  sense  the  growth  of  a  city,  by  which  barren 
areas  become  desirable  building  lots  or  factory  sites,  is  like- 
wise a  "  production  of  land."  The  recent  opening  up  of  the 
Canadian  Northwest  has  been  due  to  the  production  of  capital 
in  the  form  of  railways.  The  land  was  already  there,  but  the 
necessary  form  of  capital  was  lacking.  Another  distinction 
is  found  in  the  fact  that  land,  in  its  most  essential  qualities,  is 
a  permanent  thing,  while  capital  is  of  all  possible  degrees  of 
durability. 

These  obvious  physical  differences  between  land  and  capital 
would  hardly  justify  us  in  drawing  a  line  between  them  in  a 
discussion  of  the  distribution  of  wealth  unless  these  physical 
differences  were  the  causes  of  differences  in  the  ways  in  which 
the  incomes  from  land  and  capital  are  determined  —  differ- 
ences, that  is,  between  rent  and  interest.  Here,  again,  we  find 
points  of  similarity  and  points  of  difference.  The  points  of 
likeness  become  prominent  when  we  view  the  mechanism  of 
wealth  production  as  it  exists  at  any  given  time,  but  become  less 
significant  as  we  shift  our  view  to  the  forces  at  work  through  a 
considerable  period  of  time. 

If,  for  example,  we  could  take  something  like  an  instantaneous 
photograph  of  the  processes  of  the  production  and  distribution 
of  wealth,  we  would  see  no  important  differences  between  the 
capital  and  the  land  used  in  production.  We  would  see  that 
society  is  equipped  with  a  stock  of  capital  goods,  in  all  stages 
of  wear,  of  all  possible  degrees  of  technical  efficiency,  and  vary- 
ing greatly  in  fitness  or  adaptability  to  the  work  of  producing 
the  particular  products  that  consumers  are  demanding.  Not 
all  of  these  capital  goods  are  yielding  an  income  that  is  suffi- 
cient to  provide  for  their  replacement  as  they  wear  out,  and  in 
addition  to  pay  a  surplus,  or  premium,  in  the  form  of  interest. 
Some,  it  is  true,  may  be  yielding  even  more  than  the  amount 
necessary  for  these  purposes.     Machinery  of  new  and  excep- 


INTEREST  509 

tionally  efficient  sorts,  but  not  as  yet  of  widespread  or  general 
use ;  raw  materials  or  dealers'  stocks  of  goods  that,  by  reason  of 
a  sudden  increase  in  demand,  are  selling  at  an  exceptionally 
high  price,  —  such  capital  goods  may  be  earning  considerably 
more  than  interest  and  replacement. 

On  the  other  hand,  we  would  see  a  large  amount  of  capital  in 
such  forms  as  obsolete  kinds  of  machines,  ill-planned  factory 
buildings,  raw  materials  or  dealers'  stocks  in  trade  that  were 
bought  in  expectation  of  a  demand  that  did  not  materialize. 
Such  capital  goods  may  earn  considerably  less  than  interest  and 
replacement.  When  capital  is  once  fixed  in  definite  forms,  the 
question  of  the  original  money  cost  of  the  capital  does  not  enter 
into  the  question  of  the  profitableness  of  using  it.  An  entre- 
preneur who  borrows  money  to  invest  in  capital  goods  has  to 
repay  the  interest  and  ultimately  the  principal  of  the  loan, 
whether  this  particular  investment  of  capital  proves  sufficiently 
remunerative  or  not.  In  accounting  practice  such  expenses 
are  called  "  fixed  charges,"  because  they  go  on  whether  the  cap- 
ital is  used  profitably  or  not.  In  fact,  the  entrepreneur  will 
find  it  to  his  advantage  to  use  the  capital,  rather  than  to  let  it 
lie  idle,  so  long  as  its  use  adds  anything  to  his  total  net  income. 
A  machine  may  thus  be  worth  using,  even  if  not  worth  replac- 
ing; dealers  can  better  afford  to  sell  their  goods  for  less  than 
they  paid  for  them  than  not  to  sell  them  at  all ;  a  landlord  will 
prefer  to  rent  a  building  at  a  very  low  rate,  rather  than  to  let  it 
remain  vacant.  Capital  goods  that  are  just  barely  worth  us- 
ing may  be  called  "  marginal  capital  goods,"  and  are,  from  our 
present  viewpoint,  analogous  to  marginal  land.  At  any  given 
time,  then,  the  existing  capital  goods  which  it  does  not  pay  to 
use  may  be  thought  of  as  "  below  the  margin,"  while  the  income 
yielded  by  the  better  capital  goods  may  be  thought  of  as  a 
rent  of  capital,  analogous  in  many  ways  to  the  rent  of  land. 
For  this  reason  Professor  Marshall  has  called  the  income  from 
capital  goods,  when  the  point  of  view  takes  into  account  only 
a  short  period  of  time,  quasi-rent. 

When,  however,  we  shift  our  point  of  view  so  as  to  take  into 
account  a  longer  period  of  time,  we  see  an  important  difference 


510  OUTLINES   OF   ECONOMICS 

between  the  income  from  land  and  the  income  from  capital 
We  see,  then,  that  society's  stock  of  capital  is  a  shifting  thing. 
On  the  one  hand,  it  is  being  continually  depleted  on  account  of 
the  fact  that,  in  the  process  of  production,  capital  goods  are 
being  used  up  or  worn  out,  or  because  they  are  in  some  cases 
passing  for  other  reasons  below  the  margin  ot  profitable  use. 
On  the  other  hand,  the  stock  of  capital  is  continually  being 
replenished  by  the  investment  of  savings  in  new  forms  of 
capital  goods.  Most  of  these  investments  merely  replace  capi- 
tal that  has  been  worn  out  or  used  up,  but  some,  and  in  a  pro- 
gressive society,  a  considerable  proportion,  represent  the  crea- 
tion of  new  forms  of  capital. 

Now,  as  we  have  seen,  the  investment  of  savings  in  capital 
goods  is  guided  by  the  estimates  that  entrepreneurs  make  of  the 
profitableness  of  these  investments,  the  criterion  of  the  profit- 
ableness of  any  possible  investment  being  its  ability  at  least  to 
replace  the  principal  and  provide  for  the  interest  on  the  money 
invested.  When  experience  has  shown  that  particular  forms 
of  capital  will  not  measure  up  to  this  standard  of  profitableness, 
these  forms  will  not  be  replaced  as  they  wear  out.  When 
certain  forms  of  capital  enable  entrepreneurs  to  get  any  con- 
siderable surplus  over  and  above  interest  and  replacement,  the 
tendency  will  be,  so  far  as  competition  rules  (that  is,  so  far  as 
monopoly,  as  in  the  case  of  patented  machinery,  does  not  pre- 
vent), to  increase  the  investments  in  these  forms  of  capital,  and 
in  this  way  to  force  the  earnings  of  these  specially  advantageous 
forms  of  capital  down  to  the  common  level  of  interest  and 
replacement.  Just  as  the  expense  of  producing  consumption 
goods  forms  a  "  normal  price,"  to  which  their  actual  prices 
(under  competitive  condition)  continually  tend  to  approxi- 
mate, so  the  expenses  incurred  in  investments  in  capital  form 
a  "  normal  remuneration  of  capital"  toward  which  its  actual 
earnings  continually  tend.  Similarly,  the  price  of  capital, 
although  actually  determined  at  any  one  time,  like  the  price 
of  land,  by  its  ability  to  earn  an  income  for  its  possessor,  tends 
in  the  long  run  to  approximate  the  expense  of  producing  capi- 
tal.   This  expense  includes,  it  must  be  remembered,  both  the 


INTEREST  511 

actual  money  cost  of  new  capital  goods  and  the  expense  of  in- 
terest on  this  money  cost.  Normal  interest  is  the  interest  on 
absolutely  free  capital  in  the  form  of  loanable  Juris. 

Land,  of  course,  has  no  normal  price,  because  it  has  no  ex- 
pense, of  production.  This  difference  is  not  of  mere  theoretical 
importance,  but  has  an  important  bearing  upon  many  social 
problems.  For  example,  when  we  take  a  long  period  of  time 
into  account,  no  such  thing  as  an  "  unearned  increment  "  ap- 
pears in  the  value  of  capital.  Productivity  has  to  be  imputed 
to  capital  because  its  supply  is  limited  by  reason  of  its  expenses 
of  production  and  by  reason  of  the  sacrifices  involved  in  wait- 
ing, while  productivity  is  imputed  to  the  better  lands  simply 
because  the  supply  of  them  is  limited  by  nature.  When  we 
measure  rent  as  a  return  per  acre  (or  other  unit)  of  land,  and 
interest  as  a  percentage  on  the  money  invested,  we  recognize 
this  fundamental  distinction  between  rent  and  interest.  That 
rent  may  be  viewed  for  some  purposes  as  interest  on  the  money 
value  of  the  land,  and  that  interest  may  similarly  be  viewed 
(at  any  given  time)  as  a  "  quasi-rent  "  of  capital  goods,  does 
not  alter  the  fundamental  nature  of  the  distinction. 

We  have  seen  that  the  shifting  of  investment  by  which  the 
earnings  of  capital  are  made  to  tend  toward  a  normal  standard 
is  easier  in  the  case  of  the  more  transient  forms  of  capital 
than  in  the  case  of  the  more  durable  forms.  The  more  durable 
a  capital  good,  the  more  nearly  is  the  income  derived  from  it 
analogous  to  the  rent  of  land.  As  was  suggested  in  the  discus- 
sion of  rent,  it  is  not  necessary  or  advisable  to  draw  a  hard  and 
fast  line  between  capital  and  land.  Permanent  investments 
of  capital  in  the  form  of  improvements  to  land  may  very 
properly  be  regarded  as  land.  The  farmer  who  is  contemplating 
installing  a  drainage  system  or  an  irrigation  system  for  his 
land  views  such  an  investment,  at  the  time,  as  an  investment 
of  capital.  But  when  the  capital  is  definitely  incorporated 
with  the  land  in  these  permanent  forms,  there  is  no  reason  why 
it  should  be  called  capital  rather  than  land.  The  total  income 
yielded  by  the  improved  acres  will,  in  all  essential  particulars, 
be  land  rent. 


512  OUTLINES   OF   ECONOMICS 

The  distinction  which  we  have  drawn  between  capital  and 
land  is  not  a  mere  matter  of  names.  It  makes  little  difference 
whether  we  call  one  group  of  productive  agents  "  capital  " 
and  another  group  "  land  "  or  whether  we  class  all  of  these 
productive  agents  together  (as  many  economists  do)  under  the 
name  of  "  capital."  The  important  thing  is  that  we  should 
.see  clearly  that  there  is  one  group  of  productive  agents  whose 

rents"  are  determined  —  in  the  long  run  —  by  the  rate  of 
interest  on  loanable  funds,  and  that  there  is  another  group  of 
productive  agents  whose  earnings  are  not  so  determined. 

Capital  and  Consumption  Goods.  —  There  are  also  some 
points  of  likeness  between  capital  and  the  more  durable  forms 
of  consumption  goods.  The  person  who  buys  a  piano  is  not 
only  satisfying  his  present  wants,  but  expects  to  get  from  it  a 
long  period  of  use,  extending  into  the  future.  The  purchase  of 
any  durable  consumption  good  is  in  this  way  one  form  of  sav- 
ing for  the  future.  Moreover,  such  provisions  for  future  wants 
will  not  be  made  unless  we  feel  that  present  provision  for  these 
future  wants  is  important  enough  to  justify  us  in  giving  up 
some  possible  present  satisfaction. 

These  facts  must  be  taken  into  account  in  any  full  analysis 
of  the  valuation  of  consumption  goods,  but  they  do  not  justify 
us  in  obliterating  the  line  between  capital  and  consumption 
goods.  Consumption  goods  yield  directly  an  income  of  satis- 
factions ;  capital  yields  a  money  incotne.  A  merchant's  stock 
in  trade  is  capital  because  it  will  yield  a  money  income  to  its 
possessor;  when  sold  to  consumers,  the  same  goods  become 
consumption  goods  because  they  yield  an  income  of  satisfac- 
tions. In  short,  the  distinction  between  capital  and  consump- 
tion goods  is  based  upon  one  of  the  most  fundamental  things 
in  the  existing  economic  system  —  the  fact  that  the  incomes 
which  men  receive  for  the  productive  services  of  their  capital 
are  money  incomes. 

Capital  and  Wages.  —  In  most  undertakings  wages  are 
advanced  to  workmen  engaged  in  the  production  of  goods  before 
the  goods  are  sold.  A  farmer,  for  example,  has  to  pay  his 
harvest  hands  and  other  workmen  before  he  receives  any  money 


INTEREST  513 

from  the  sale  of  his  wheat.  Whether  he  borrows  the  amount 
needed  for  wages,  or  whether  he  pays  them  out  of  his  own  sav- 
ings, interest  on  the  amount  advanced  has  to  be  counted  among 
the  expenses  of  production,  and  the  wages  advanced  are,  for 
the  time  being,  an  investment  of  capital.  In  most  manufactur- 
ing establishments  a  more  or  less  lengthy  average  period  of 
time  elapses  between  the  work  actually  done  by  the  workmen  and 
the  sale  of  the  products  of  their  work.  In  such  establishments 
a  considerable  amount  of  capital  is  invested  in  wage  advances. 
This  does  not  mean  that  we  are  to  consider  the  laborers  as  being 
in  any  sense  capital.  For  the  gradual  process  by  which  the 
raw  material  becomes  the  finished  product  is  itself  a  continuous 
investment  of  capital.  All  of  the  various  expenses  of  production 
are  really  different  ways  of  investing  money  in  capital  goods. 
Add  to  the  cost  of  the  raw  material  all  of  the  expenses  (including 
wages  and  payments  of  rent  and  interest  as  well)  incurred  in 
order  to  produce  the  finished  product  of  the  establishment, 
and  you  have  simply  the  total  investment  in  capital  goods  in 
the  form  of  the  finished  product.  A  complete  inventory  of 
capital  goods  would  include  then  (in  addition  to  buildings, 
machinery,  etc.)  not  only  raw  materials  and  the  finished  prod- 
ucts that  are  ready  for  sale  to  consumers,  but  also  the  prod- 
ucts on  hand  at  any  one  time  in  a  partly  finished  state.  Thus, 
though  the  payment  of  wages  is  often  an  investment  of  capital, 
it  must  be  remembered  that  the  payment  of  wages  is  only  one 
of  the  ways  in  which  money  is  invested  in  concrete,  definite, 
capital  goods. 

Competitive  Investment.  —  Thus  far  our  discussion  has  run 
in  terms  of  the  investment  of  money  in  what  we  have  just  called 
"  concrete,  definite,  capital  goods,"  to  be  used  in  the  produc- 
tion of  other  goods.  We  have  pictured  entrepreneurs  and 
capitalists  as  servants  of  society,  —  as  investing  money  in 
producing  the  things  people  want  and  are  willing  to  pay  for. 
But  in  order  to  portray  some  of  the  essential  facts  of  modern 
business  enterprise  this  picture  has  to  be  modified.  Business 
men  are  primarily  interested  in  acquisition  rather  than  in  pro- 
duction, in  making  money  rather  than  in  making  goods.     From 


514  OUTLINES  OF   ECONOMICS 

the  point  of  view  of  both  the  entrepreneur  and  the  capitalist, 
money  is  invested  to  yield  an  income  rather  than  to  increase  the 
aggregate  output  of  consumable  goods. 

In  part,  and  in  very  large  part,  it  is  true,  investments  yield  an 
income  because  they  further  the  production  of  things  that 
satisfy  human  wants.  Such  is  the  case  in  general  with  (income- 
yielding)  investments  in  agriculture  and  in  other  industries 
where  the  products  of  competing  establishments  cannot  be 
distinguished,  one  from  another,  and  are  sold  in  a  general 
market  where  prices  are  fixed  very  accurately  by  general  com- 
petitive conditions.  But  there  is  left  a  very  important  field  of 
enterprise  in  which  the  entrepreneur  may  find  it  worth  while 
to  invest  large  amounts  of  money  in  "  selling  expenses."  Put 
in  a  very  general  but  roughly  accurate  way,  these  expenses  are 
incurred,  not  in  producing  things  people  want,  but  in  inducing 
people  to  want  the  particular  things  the  entrepreneur  has  for 
sale.  Advertising  expenditures  are  the  most  obvious  form  of 
such  investments.  Part  of  the  salaries  paid  to  traveling  sales- 
men must  also  be  placed  under  this  head.  Sometimes  a  new 
establishment  will  be  created,  with  full  knowledge  of  the  fact 
that  it  must  run  at  a  loss  until  a  demand  for  its  products  is 
developed.  Such  losses  are  investments  of  this  type.  Two 
thirds  or  more  of  the  aggregate  expenses  of  many  establishments 
making  patent  medicines  are  selling  expenses.  And  in  the  manu- 
facture and  sale  of  other  products  enormous  investments  are 
made  with  the  purpose  of  creating  and  holding  a  market  for 
goods  marked  by  particular  brands  and  trade-marks.  A  note- 
worthy feature  of  modern  business  is  the  attempt  on  the  part  of 
manufacturers  and  wholesalers  to  influence  the  demand  of  ulti- 
mate consumers  through  advertising. 

From  the  point  of  view  of  the  individual  competitor  such 
expenses  and  the  expenses  of  buying  or  making  capital  goods 
are  alike  "  investments."  But  they  are  competitive,  acquisi- 
tive, investments  rather  than  socially  productive  investments. 
Their  purpose  is  not  to  satisfy  an  existing  demand  but  to  shift 
demand  from  other  channels.  So  far  as  such  expenditures 
succeed  in  gaining  trade,  the  capitalized  income-yielding  power 


INTEREST  515 

of  a  business  undertaking  will  be  greater  than  the  "  capital 
values  "  that  can  be  imputed  to  the  stock  of  capital  goods  on 
hand.  These  surplus  capital  values,  embodied  only  in  the 
preferences  of  consumers  for  particular  products,  may  be 
recorded,  like  other  values,  in  the  actual  price  paid  when  the 
business  is  sold. 

This  is  not  to  say  that  all  selling  expenses  are  from  the  social 
point  of  view  wasteful.  Some  of  the  things  for  which  a  mar- 
ket is  thus  created  may  be  better  things,  judged  by  rational 
standards,  than  the  things  which  they  displace.  Moreover, 
scrupulously  truthful  advertising  is  frequently  a  real  help  to 
the  consumer,  perplexed  by  the  range  of  alternative  choices 
open  to  him,  and  often  without  knowledge  of  the  qualities  of 
competing  goods  or  of  their  fitness  to  serve  his  purposes.  But 
this  is  only  an  incidental  and  by  no  means  a  necessary  result  of 
these  competitive  investments.  They  may  sometimes  lead  to 
the  education  of  the  consumer,  but  they  may  also  lead  to  the 
exploitation  of  weakness  and  ignorance.  And  in  either  case  they 
are  no  part  of  the  social  process  of  the  "  production  of  goods." 

The  Flow  of  Money  Income.  —  We  now  come  to  the  heart  of 
our  problem,  —  the  analysis  of  the  general  forces  determining 
the  rate  of  interest.  For  this  purpose  we  shall  find  it  conven- 
ient to  examine  the  general  process  of  the  flow  of  money  l 
income.  There  is  a  continuous  flow  of  money  income  through 
the  hands  of  entrepreneurs,  appearing  first  in  the  form  of  the 
prices  that  are  paid  them  for  their  goods,  then  (neglecting 
profits)  in  their  own  payments  for  labor,  land,  and  capital, 
then  reappearing  in  the  prices  which  those  who  furnish  these 
agents  in  production  pay  for  other  goods,  and  so  on  in  a  con- 
tinually recurring  cycle  of  income  and  outgo. 

This  process  is  made  more  complicated,  however,  by  the  fact 
that  not  all  of  the  entrepreneur's  expenses  appear  directly  as 
rent,  wages,  or  interest.  A  considerable  part,  and  in  many 
cases  (as  in  mercantile  establishments),  the  largest  part  of  such 
expenditures  is  for  various  concrete  forms   of  capital,  —  raw 

1  Using  the  word  money  in  its  broadest  sense,  including  such  transferable  credit 
instruments  as  are  used  in  making  payments. 


516  OUTLINES   OF   ECONOMICS 

materials,  dealer's  stocks  of  goods,  machines,  etc.,  —  and  for 
advertising  as  well.  Here  a  part  of  the  money  income  received 
by  the  entrepreneur  in  the  form  of  the  prices  paid  for  his  own 
goods  emerges  in  the  prices  which  he  pays  for  the  goods  sold  by 
other  entrepreneurs,  and  which,  in  turn,  make  up  a  part  of  their 
money  incomes.  But  this  other  class  of  entrepreneurs  —  who 
supply  capital  goods  rather  than  consumption  goods  —  are 
subject  to  the  same  necessity  of  expending  their  money  incomes 
in  the  payment  of  wages,  rent,  and  interest,  and  in  the  purchase 
of  different  kinds  of  capital  goods.  To  push  the  analysis  still 
further  would  obviously  lead  us  only  into  needless  repetition. 
One  important  fact,  however,  appears  clearly:  If  we  could 
trace  the  expense  of  producing  any  consumption  good  back 
through  all  the  long  series  of  services  and  of  production  goods 
that  have  contributed  to  its  making  we  would  find  that  this 
expense  reduces  itself,  ultimately,  to  rent,  wages,  and  interest,  not 
counting  what  remains  in  the  entrepreneur's  hands  as  profits. 
Part  of  the  flow  of  money  income  passes  through  the  hands  of  a 
chain  of  entrepreneurs,  but  it  nevertheless  originates  in  the 
prices  that  consumers  pay  for  the  things  that  satisfy  their 
wants  and  emerges  in  the  form  of  the  payments  made  for  the 
productive  services  of  land,  labor,  and  capital. 

Yet  another  correction  must  be  made,  however,  to  fit  this 
picture  of  part  of  the  economic  process  more  closely  to  the  facts. 
The  money  which  consumers  pay  for  particular  commodities 
does  not  usually  constitute  the  actual  fund  with  which  the 
entrepreneur  pays  for  the  labor,  the  land,  and  the  capital  goods 
used  in  the  production  of  those  particular  commodities.  Still 
less  does  it  constitute  the  actual  fund  from  which  the  entre- 
preneurs who  supply  the  necessary  capital  goods  pay  their 
expenses,  or  from  which  the  expenses  of  still  more  remote  stages 
in  the  process  of  production  are  paid.  The  roundabout,  in- 
direct methods  which  characterize  modern  production,  and 
which  involve  the  division  of  the  productive  process  among 
countless  different  undertakings,  take  time.  The  goods  which 
consumers  buy  today  are  the  result  of  a  long  series  of  produc- 
tive efforts  extending  back  indefinitely  into  the  past.     Simi- 


INTEREST  517 

Iarly  the  productive  efforts  of  today  avail  but  relatively  little 
toward  the  satisfaction  of  present  wants,  for  they  are  in  large 
part  directed  to  forwarding,  often  in  the  most  indirect  ways, 
the  production  of  things  that  will  come  to  a  final  fruition  in  the 
satisfaction  of  human  wants  only  in  the  more  or  less  remote 
future. 

The  Annual  Product  and  the  Social  Dividend.  —  Viewed  in 
this  way  the  annual  product  of  society  is  something  very  differ- 
ent from  the  social  dividend.  The  year's  work  is  begun  with  an 
equipment  of  economic  goods  of  all  kinds,  —  finished  goods  in 
the  hands  of  dealers  and  manufacturers,  goods  in  all  stages  of 
completion,  growing  crops,  factory  and  mercantile  buildings, 
machines,  and  all  the  auxiliary  apparatus  of  production  in  a 
finished  or  unfinished  state.  The  annual  product  includes  all 
the  additions  made  to  this  stock  of  goods,  and  all  that  is  accom- 
plished in  forwarding  such  goods  as  are  destined  for  human 
consumption  towards  the  form,  place,  and  time  in  which  and 
at  which  they  are  wanted.  It  includes  all  that  is  done  in  a 
similar  way  to  forward,  replenish,  and  increase  the  stock  of 
production  goods.  It  includes  also  all  the  personal  services 
that  command  a  money  payment  which  are  not  embodied  in 
concrete  goods,  but  which  confer  their  benefits  in  the  very  in- 
stance of  their  performance. 

But  while  the  productive  efforts  of  society  are  thus  constantly 
building  up  and  modifying  the  stock  of  economic  goods,  this 
stock  is  continually  being  depleted  in  various  ways.  The 
instruments  of  production  are  constantly  wearing  out,  or  are 
being  cast  aside  on  account  of  the  introduction  of  either  more 
efficient  appliances  or  more  efficient  methods  which  utilize 
other  kinds  of  appliances.  Then,  too,  as  the  final  outcome  of 
this  productive  process  there  is  a  constant  stream  of  finished 
consumption  goods  passing  into  the  hands  of  consumers.  The 
social  dividend  consists  of  this  flow  of  consumption  goods,  to- 
gether with  those  direct  personal  services  which  do  not  have  to 
do  directly  or  indirectly  with  the  fitting  of  goods  for  human 
consumption,  but  which  nevertheless  satisfy  wants  and  com- 
mand a  money  payment.     While  the  social  dividend  is  to  a 


518  OUTLINES   OF   ECONOMICS 

large  extent  the  outcome  of  past  work  and  effort,  the  annual 
product  is  very  largely  a  provision  for  future  wants. 

What  is  the  effect  of  all  these  considerations  upon  our  analysis 
of  the  flow  of  money  income?  It  still  remains  true  that  the 
money  which  consumers  pay  to  entrepreneurs  is  in  turn  used 
by  them  in  the  payment  of  their  expenses  of  production,  and 
that  the  money  which  they  in  turn  pay  to  other  entrepreneurs 
for  various  forms  of  capital  goods  is  used  in  the  payment  of 
expenses  of  production.  But  the  prices  consumers  are  paying 
are  for  goods,  the  expenses  of  producing  which  have  (at  least  in 
greater  part)  already  been  paid.  If  we  should  trace  back  the 
expenses  of  producing  the  capital  goods  used  in  producing  these 
consumption  goods  our  search  would  lead  us  into  the  more 
remote  past,  while  still  further  analysis  of  the  expenses  of  pro- 
duction would  discover  an  increasing  number  of  ramifications 
running  back  into  the  still  more  distant  past.  The  present 
flow  of  money  income,  originating  in  the  prices  paid  by  con- 
sumers, passes,  as  we  have  seen,  through  the  hands  of  a  chain 
of  entrepreneurs  and  in  this  process  gets  ultimately  into  the 
hands  of  laborers,  capitalists,  and  landlords.  But  most  of  the 
productive  services  which  are  thus  remunerated  are  services 
which  will  avail  toward  the  satisfaction  of  future  rather  than  of 
present  wants.  In  other  words,  the  prices  paid  for  consumers' 
shares  in  the  social  dividend  constitute  (save  for  an  important 
exception  to  be  noted  presently)  the  fund  which  pays  for  the 
annual  product.  The  productive  efforts  of  the  past,  which  satisfy 
the  wants  of  today,  were  paid  for  out  of  past  income,  while  the 
present  work  of  producing  good*  that  will  be  ripe  for  consumption 
only  in  the  future  is  paid  for  out  of  present  income.  In  this  fact 
lies  the  kernel  of  the  interest  problem. 

Investment  a  Cumulative  Process.  —  Not  only,  as  we  have 
seen,  does  the  entrepreneur  invest  in  such  things  as  machines 
and  buildings,  but  his  purchases  of  raw  materials,  his  advances 
of  wages  to  laborers,  the  interest  which  he  pays  on  borrowed 
capital,  the  rent  or  the  purchase  price  which  he  pays  for 
land,  and  his  various  competitive  selling  expenses  are  also  in- 
vestments.    No  such  investments  can  be  regarded  as  remu- 


INTEREST  519 

nerative  unless  the  entrepreneur  gets  in  the  selling  prices  of  his 
products  enough  to  provide  interest  upon  such  outlays  as  well  as 
to  cover  the  outlays  themselves.  These  facts  have  already 
been  noted,  but  at  first,  for  simplicity's  sake,  we  confined  our 
analysis  to  the  capital  expenditures  of  the  individual  entre- 
preneur. The  full  significance  of  the  role  which  capital  plays  in 
production  does  not  appear  until  we  view  the  activities  of  the 
individual  entrepeneur  as  only  a  link  in  the  continuous  chain  of 
activities  that  make  up  the  productive  process. 

The  point  of  special  significance  in  this  connection  is  the  fact 
that  the  finished  products  sold  by  some  entrepreneurs  constitute 
the  capital  goods  (raw  materials,  productive  appliances,  adver- 
tising media,  etc.)  bought  by  other  entrepreneurs.  When  one 
entrepreneur  sells  his  products  to  another  entrepreneur  his 
period  of  "  waiting  "  is  completed,  so  far  as  his  advances  of 
money  funds  in  the  production  of  these  particular  units  of  goods 
are  concerned.  But  the  "  waiting  "  is  only  transferred  to  the 
other  entrepreneur,  who  adds  further  expenditures  of  money 
and,  in  turn,  gets  his  remuneration  from  the  sale  of  his  product. 
The  important  conclusion  to  which  this  analysis  leads  is  that 
(so  far  as  the  entrepreneurs  have  been  accurate  in  their  esti- 
mates) the  prices  which  consumers  are  paying  today  for  finished 
goods  cover  not  only  all  the  actual  money  expenditures  which 
have  been  made  in  the  past  in  the  production  of  these  goods, 
but  also  the  interest  on  all  such  expenditures  from  the  time 
they  were  made  up  to  the  time  of  the  sale  of  the  finished  goods 
to  the  ultimate  consumer. 

Similarly  the  expenditures  made  by  entrepreneurs  today  in 
the  production  of  goods  that  will  directly  or  indirectly  satisfy 
future  wants  must  (so  far  as  these  entrepreneurs  and  those  who 
will  control  the  remaining  steps  in  the  productive  process  are 
accurate  in  their  estimates)  be  covered,  together  with  accrued 
interest,  by  the  prices  which  consumers  will  pay  in  the  future. 
Present  wants  are  satisfied  by  means  of  the  productive  efforts  of 
the  past.  These  productive  efforts  were  paid  for  out  of  past 
income,  but  the  outlays  were  made  in  the  expectation  that  pres- 
ent prices  would  suffice  to  repay  them,  with  interest.     A  par- 


520  OUTLINES   OF   ECONOMICS 

ticular  entrepreneur  may  be  interested  only  in  disposing  of  his 
products  at  remunerative  prices  to  the  entrepreneurs  who  stand 
next  to  him  in  the  productive  series,  but  this  does  not  alter  the 
essential  nature  of  investment,  which,  from  the  social  point  of 
view,  is  a  cumulative  process. 

The  Sources  of  Investment  Funds.  —  The  gross  money  in- 
come of  entrepreneurs  furnishes  by  far  the  most  important  part 
of  the  current  supply  of  investment  funds,  and  the  most  im- 
portant form  of  investment  is  found  in  the  entrepreneur's 
customary  practice  of  "  putting  money  back  into  the  business.'' 
That  this  way  of  investing  money  is  customary,  even  habitual, 
does  not  mean  that  the  amount  as  well  as  the  particular  forms 
of  such  investments  is  not  a  matter  subject  to  the  discretion 
of  the  entrepreneur.  So  far  as  the  entrepreneur  is  not  hampered 
by  contracts  (with  customers,  other  entrepreneurs,  money 
lenders,  landlords,  or  laborers)  he  is  free  to  do  as  he  pleases 
with  his  income.  As  a  matter  of  fact  he  is  likely  to  devote  a 
fairly  constant  proportion  of  it  to  the  replacement  of  the  capital 
goods  that  are  being  used  up  or  worn  out  and  to  the  other 
necessary  expenses  of  continued  production. 

It  rarely  happens,  however,  in  any  undertaking,  that  income 
and  expenditure  are  so  nicely  adjusted  and  so  evenly  distributed 
through  the  year  that  the  one  always  suffices  to  provide  for  the 
other.  A  temporary  surplus  may  be  followed  by  a  temporary 
deficit.  Transfers  of  goods  on  credit,  helped  out  by  the  institu- 
tion of  banking,  smooth  over  some  of  these  irregularities.  More- 
over, while  the  entrepreneur  need  not  continue  to  renew  his 
capital  investments  unless  he  chooses,  he  is  at  liberty  to  do  even 
more  than  this  if  he  deems  it  advisable.  That  is,  his  profits  — 
the  excess  of  his  gross  income  over  and  above  Hs  current  and 
normal  capital  expenditures  —  may  be  used  for  additional  capital 
expenditures. 

Still  another  source  of  capital  funds  is  found  in  the  rent,  wages, 
and  interest  into  which,  as  we  have  seen,  the  expenses  of  produc- 
tion ultimately  resolve  themselves.  For  so  far  as  these  forms  of 
income  are  saved  by  their  recipients,  rather  than  expended  im- 
mediately for  consumption  goods,  they  may  be  lent  directlv  or 


INTEREST  521 

through  savings  institutions  to  entrepreneurs.  This  is  the 
important  exception,  previously  mentioned,  to  the  statement 
that  "  the  prices  paid  for  consumers'  shares  in  the  social  dividend 
constitute  the  fund  which  pays  for  the  annual  product."  The 
truth  is  that  as  the  flow  of  money  income  passes  from  entre- 
preneur to  entrepreneur,  a  part  only,  although  the  larger  part,  is 
put  into  expenditures  for  gain.  The  residuum  is  used  by  entre- 
preneurs in  paying  for  their  own  shares  in  the  social  dividend. 
In  much  the  same  way  the  money  income  received  by  those  who 
furnish  labor,  land,  or  capital  is  only  in  part  paid  back  to  entre- 
preneurs in  return  for  consumption  goods,  the  residuum  being 
put  (through  loans  to  entrepreneurs)  into  expenditures  for  gain. 
The  Interest  Rate.  —  It  will  be  seen,  then,  that  as  the  flow 
of  money  income  passes  through  the  hands  of  entrepreneurs, 
laborers,  capitalists,  and  landowners,  it  is  divided  into  two 
streams,  one  of  which  goes  to  pay  for  the  present  goods  that  have 
been  produced  in  the  past,  while  the  other  goes  to  pay  for  the 
present  expenses  of  forwarding  the  production  of  goods  for  future 
consumption.  This  division  represents  a  kind  of  social  balanc- 
ing of  possible  present  satisfactions  over  against  the  larger  future 
satisfactions  which  the  productive  use  of  capital  makes  possible. 
On  the  one  hand  we  have  the  entrepreneurs'  estimates  of  how 
much  specific  amounts  of  capital  funds  are  worth  to  them, — 
estimates  which  involve  judgments  as  to  the  amount  of  salable 
product  dependent  upon  the  use  of  these  specific  amounts  of 
capital  funds,  the  prices  that  can  be  got  for  such  products,  and 
the  period  of  time  that  will  elapse  before  they  will  be  remuner- 
ated for  such  investments.  On  the  other  hand  we  have  the 
judgments  of  those  who  supply  capital  funds  as  to  the  relative 
importance  of  future  and  present  satisfactions.  The  interest 
rate  will  normally  be  fixed,  of  course,  at  a  point  where  the  supply 
and  demand  of  money  funds  for  investment  will  be  in  equi- 
librium.1 

1  Short-time  fluctuations  in  the  interest  rate  are  dependent  very  largely  on  the 
condition  of  bank  reserves.  This  relation  has  been  explained  in  the  chapters  on 
money  and  banking.  In  the  long  run,  however,  it  is  the  "supply  of  waiting"  that 
\s  the  important  thing. 


522  OUTLINES  OF   ECONOMICS 

The  process  of  production  involves  the  expenditure  of  rent, 
wages,  and  interest  for  returns  of  all  possible  degrees  of  futurity, 
and  a  consequent  comparison  and  balancing  of  the  productivity 
of  investments  for  shorter  and  longer  periods  of  time.  That  is, 
social  estimates  x  of  productivity  are  estimates  of  the  relative 
importance  of  the  ultimate  products,  realizable  at  different 
peiiods  of  time  in  the  future,  that  are  dependent  upon  specific 
present  expenditures  in  the  form  of  rent,  wages,  or  interest. 
Or,  in  other  words,  there  is  a  continuous  effort  to  make  the  most 
advantageous  of  all  the  various  possible  combinations  of  land,  labor, 
and  waiting.  For  just  as  rent,  wages,  and  interest  are  the 
ultimate  expenses  of  production,  so  the  ultimate  factors  in 
production  may  be  said  to  be  land,  labor,  and  waiting. 

The  entrepreneur  bases  his  demand  for  investment  funds 
upon  his  estimate  of  the  demand  for  his  products,  together  with 
his  estimate  of  the  relative  economy  of  the  use  of  methods  call- 
ing for  greater  or  less  degrees  of  "  roundaboutness,"  involving 
different  amounts  of  waiting  on  the  part  of  himself  and  of 
others  who  supply  him  with  investment  funds.  This  means 
that  the  interest  rate  is  itself  one  of  the  factors  determining 
the  demand  for  waiting.  The  higher  the  rate  of  interest,  the 
greater  will  be  the  expense  of  using  roundabout  methods,  in- 
volving much  waiting. 

The  supply  of  waiting  varies  with  the  interest  rate.  Other 
things  being  equal,  the  higher  the  interest  rate,  the  larger  will  be 
the  parts  of  money  incomes  that  will  be  saved  rather  than  spent 
immediately  in  the  satisfaction  of  wants.  It  has  sometimes  been 
said  that  saving  increases  as  wealth  increases.  If  this  is  taken  to 
mean  that  the  larger  the  income  of  the  individual,  the  larger, 
other  things  being  equal,  will  be  the  amount  he  will  save,  the 
statement  probably  expresses  a  general  truth.  The  larger  the 
income,  the  less  important  are  the  immediate  wants  dependent 
for  their  satisfaction  on  a  given  amount  of  money.  It  does  not 
follow  that  the  proportion  of  the  income  that  is  saved  is  apt  to  be 

1  By  "social  estimates"  of  productivity  we  mean  only  the  net  outcome  of  the  indi- 
vidual estimates  of  all  the  different  individual  buyers  and  sellers,  lenders  and 
borrowers. 


INTEREST  523 

any  larger  in  the  case  of  a  large  income  than  a  small  income. 
If,  on  the  other  hand,  the  statement  is  taken  to  refer  to  the  in- 
crease of  wealth  in  society  at  large,  we  have  to  take  account  of 
the  fact  that  as  wealth  increases  new  wants  develop,  and  the  net 
effect  on  saving  is  apt  to  depend  on  the  character  of  the  new 
wants,  —  whether  they  call  for  increased  current  expenditures  or 
whether  they  involve  the  accumulation  of  considerable  sums. 
Convenient  opportunities  for  saving,  such  as  those  afforded  by 
savings  banks,  insurance  companies,  and  the  supply  of  con- 
venient forms  of  investment  securities  have  (apart  from  the  rate 
of  interest  they  offer)  an  important  effect  upon  the  amount  of 
saving. 

Gross  Interest  and  Net  Interest.  —  Net  interest  is  pure  inter- 
est —  the  amount  actually  necessary  to  recompense  marginal 
waiting.  Gross  interest  —  the  interest  actually  paid  on  loans 
—  includes  payments  for  other  things.  In  the  first  place, 
actual  interest  often  includes  some  payment  for  the  supervision 
which  the  capitalist  has  to  maintain  over  his  investment.  Even 
the  man  who  "  lives  on  his  income  "  usually  has  to  devote  a 
certain  amount  of  time  to  the  investigation  of  the  safety  of 
different  possible  investments,  to  the  collection  of  interest  and 
principal  and  similar  things.  The  net  earnings  of  savings 
banks  —  the  difference  between  the  interest  they  get  on  their 
investments  and  the  interest  they  pay  their  depositors  —  are 
partly  a  payment  for  this  element  of  supervision. 

A  second  element  in  gross  interest  is  the  payment  for  the  risk 
the  lender  undergoes  of  losing  all  or  part  of  his  expected  return 
(including  principal  and  interest).  This  does  not  mean,  as  some 
writers  have  said,  that  the  interest  rate  contains  an  element  of 
insurance,  for  insurance  means  the  elimination  of  individual  risk 
through  the  combination  of  risks.  The  fact  is  simply  that,  as 
every  one  knows,  lenders  will  not  take  greater  risks  without  the 
prospect  of  greater  gains.  There  is  some  element  of  speculation 
in  all  loans  but  the  very  safest,  and  the  extra  income  received  on 
the  more  legitimate  loans  is  profit  rather  than  insurance. 

Usury  Laws.  —  Interest  is  one  form  of  price  in  regard  to  which 
society  still  expresses  some  distrust  of  the  operation  of  un- 


524  OUTLINES   OF   ECONOMICS 

hindered  competitive  forces.  Only  nine  American  states  do  not 
provide  a  legal  maximum  above  which  the  interest  rate  cannot 
legally  be  fixed.  Such  laws  are  based  on  the  justifiable  assump- 
tion that  the  borrower  is  in  many  cases  the  weaker  bargainer, 
pressed  often  by  that  necessity  which  "  never  drove  a  good 
bargain."  In  many  places  the  laws  are  not  enforced,  but  else- 
where they  have  an  important  effect  on  some  kinds  of  loans, 
especially  bank  loans  in  the  rural  districts,  —  farm  mortgages 
and  overdue  book  credits.  It  is  to  be  feared,  however,  that  their 
result  is  often  not  so  much  to  lower  the  rate  of  interest  as  to  cut 
off  many  loans  which  lenders  would  not  be  justified  in  making 
except  at  high  rates  of  interest.  In  the  case  of  many  loans  on 
fairly  good  security,  however,  usury  laws  have  probably  operated 
to  the  advantage  of  the  borrowers. 

QUESTIONS 

i.   Could  a  socialist  state  dispense  with  interest?   with  waiting? 

2.  How  has  the  rate  of  interest  been  affected  by  the  opening  up  of  new 
and  fertile  lands? 

3.  Use  supply  and  demand  curves  to  illustrate  the  determination  of  the 
rate  of  interest. 

4.  Is  a  rented  house  capital  or  a  consumption  good? 

5.  Analyze  the  effect  of  an  increase  of  expenditures  for  present  goods 
upon  present  and  future  social  dividends. 

6.  If  money  wages  could  be  suddenly  increased  by  10  per  cent  would 
there  be  a  corresponding  increase  in  real  wages? 

7.  Are  the  roulette  tables  at  Monte  Carlo  capital?     Is  a  burglar's  jimmy 
capital?     Is  a  battleship  capital? 

REFERENCES 

Bohm-Bawerk,  E.  von.     Capital  and  Interest;  Positive  Theory  of  Capital, 

Books  v-vii. 
Carver,  T.  N.     The  Distribution  of  Wealth,  Chap.  vi. 
Cassell,  G.     The  Nature  and  Necessity  of  Interest. 
Davenport,  H.  J.     Economics  of  Enterprise,  Chaps,  xviii-xxi. 
Fisher,  Irving.     Capital  and  Income;  The  Rate  of  Interest. 
Gonner,  E.  C.  K.     Interest  and  Saving. 
Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Vol.  i,  Book  ii, 

Chap,  iv;   Book  iv,  Chap,  vii;   Book  vi,  Chap.  vi. 
Taussig,  F.  W.    Principles  of  Economics,  Vol.  ii,  Chaps,  xxxviii-xl. 


CHAPTER  XXV 
PROFITS 

The  difference  between  the  total  money  income  which  an 
entrepreneur  receives  and  his  expenses  of  production  consti- 
tutes his  profits.  Profits,  then,  are  a  surplus  over  and  above 
the  expenses  of  production.  There  are  two  ways  of  measuring 
profits:  first,  with  reference  to  some  unit  of  time,  such  as  a 
year ;  and,  second,  with  reference  to  particular  units  of  product. 
Thus,  when  a  manufacturer  speaks  of  his  profits  during  a  year, 
he  has  in  mind  the  difference  between  his  total  expenditures  and 
total  receipts  for  that  year.  But  when  he  speaks  of  his  profits 
on  a  particular  sale,  he  has  in  mind  the  difference  between  the 
expense  of  producing  and  selling  the  particular  goods  sold  and 
the  prices  received  for  them.  The  two  ways  of  measuring 
profits  are  not  alike,  because  a  large  part  of  the  expenses  in- 
curred by  an  entrepreneur  in  any  given  year  may  be  payments 
for  work  done  in  connection  with  the  production  of  goods  that 
will  not  be  marketed  until  some  time  later.  In  the  long  run, 
however,  the  amount  of  annual  profits  will  be  determined  by 
the  profits  on  particular  transactions  or  on  particular  products, 
so  that  for  present  purposes  it  is  not  necessary  to  press  the  dis- 
tinction any  farther.  It  is  sometimes  more  convenient  to  use 
the  word  "  profits  "  in  one  sense,  and  sometimes  in  the  other 
sense. 

Profits,  being  a  surplus,  do  not  constitute  a  homogeneous 
income  determined  by  any  one  principle  or  set  of  principles. 
They  are  the  resultant  of  all  the  forces  that  tend  to  bring  about 
inequalities  between  the  prices  paid  for  things  and  the  expenses 
of  producing  them.  It  is  not  possible  in  a  brief  analysis  even 
to  attempt  to  break  up  this  mixed  form  of  income  into  ail  of 

525 


526  OUTLINES  OF  ECONOMICS 

its  constituent  parts.  But  we  must  distinguish  between  two 
different  elements  in  what  are  commonly  called  profits,  namely 
entrepreneur's  wage  and  pure  profits. 

Entrepreneur's  Wage.  —  This  element  in  profits  is  sometimes 
called  the  "  wages  of  management,"  and  constitutes  the  pay- 
ment received  by  the  entrepreneur  for  his  services  as  manager 
or  supervisor  of  his  business.  It  is  not  easy  to  draw  a  line  be- 
tween this  element  in  profits  and  wages.  In  fact,  "  entrepre- 
neur's wage  "  could  be  discussed  just  as  appropriately  under 
the  general  head  of  wages  as  in  connection  with  the  general 
subject  of  profits.  The  only  distinguishing  things  about  this 
particular  kind  of  wages  are  that,  unless  the  entrepreneur 
adopts  the  bookkeeping  form  of  paying  wages  to  himself,  they 
come  out  of  the  general  surplus  or  residuum  commonly  called 
profits  in  actual  business,  and  that  they  are  the  wages  paid  for 
a  particular  kind  of  labor. 

The  average  American  farmer  usually  does  a  certain  amount 
of  work  himself  that  might  be  done  by  hired  laborers,  and  so 
far  as  his  income  represents  the  amount  he  saves  by  doing  such 
work  himself,  it  is  to  be  regarded  as  ordinary  wages.  But  in 
addition,  he  does  other  work  of  a  more  purely  managerial 
quality,  including  the  general  direction  of  the  time  and  methods 
of  tillage  and  harvesting,  the  organization  of  the  working  force ;. 
in  fact,  the  determination  of  what  may  be  succinctly  described 
as  the  general  coordination  of  labor,  capital,  and  land.  The 
reader  may  ask:  Could  not  this  part  of  the  work  be  turned 
over  to  a  salaried  foreman?  Certainly,  and  in  some  cases, 
as  on  the  estates  of  so-called  "  gentlemen  farmers,"  all  of  it. 
In  fact,  the  amount  of  the  managerial  work  actually  done  by 
the  entrepreneur  himself  in  any  kind  of  undertaking  is  a  variable 
quantity,  depending  upon  the  extent  to  which  managerial 
authority  is  delegated  to  foremen,  superintendents,  and  salaried 
managers.  In  the  case  of  corporations  practically  all  of  the 
actual  work  of  management  is  intrusted  to  officials  and  em- 
ployees whose  salaries  are  counted  among  the  expenses  of 
operation.  In  any  case  the  "  wages  of  management  "  exist, 
although  they  do  not  always  exist  as  "  entrepreneur's  wage," 


PROFITS  527 

nor  do  they  always  constitute  a  part  of  what  is  called  profits 
in  the  accounting  of  the  enterprise. 

Even  in  cases  where  the  entrepreneur  is  in  all  respects  his  own 
manager  (which  is,  after  all,  the  most  frequent  case  in  a  host  of 
small  business  undertakings),  the  entrepreneur's  wage  con- 
stitutes a  kind  of  minimum  profits,  and  is  in  reality  a  part  of 
the  expenses  of  production.  Minimum  profits  are  necessary 
profits,  the  money  price  needed  to  induce  the  entrepreneur  to 
engage  in  and  continue  his  work.  They  can  be  measured 
roughly  by  the  salary  which  the  entrepreneur  could  get  by 
working  for  some  one  else.  Some  men  would  prefct*  to  be 
their  own  masters  even  at  a  smaller  income,  while  othfcys  would 
shrink  from  the  responsibilities  of  independent  business  life, 
even  if  a  larger  income  were  attached  to  it,  so  this  method  of 
measuring  minimum  profits  is  only  approximate. 

Minimum  profits  will  vary  with  managerial  efficienr/.  The 
more  efficient  farmer  will  get  a  larger  product  with  a  given 
equipment  of  land,  labor,  and  capital  than  will  the  less  efficient 
farmer.  So  will  the  more  efficient  manufacturer.  Diiferences 
in  managerial  efficiency  will  cause  corresponding  differences 
in  minimum  profits. 

Pure  Profits  Impossible  under  Certain  Conditions.  —  It  will 
help  us  to  get  a  notion  of  the  meaning  of  pure  profits  and  of  the 
sources  from  which  they  are  obtained  if  we  pause  to  consider 
the  conditions  under  which  they  could  not  exist.  Under  what 
conditions  would  the  selling  prices  of  goods  always  be  just 
about  equal  to  the  expenses  of  producing  them  (including  the 
wages  of  management)  ?  Under  what  conditions,  in  other 
words,  would  market  prices  always  be  kept  approximately 
equal  to  normal  prices? 

The  first  prerequisite,  it  is  clear,  is  a  very  complete  and 
perfect  state  of  competition.  Capital  and  labor  would  have 
to  be  so  fluid  that  they  could  be  shifted  from  one  employment 
to  another  to  take  advantage  of  the  slightest  possible  differences 
in  gains.  In  the  second  place,  it  is  not  sufficient  that  business 
men,  capitalists,  and  laborers  should  be  quick  to  take  advan- 
tage of  their  opportunities;    they  would  have  to   know  their 


528  OUTLINES  OF  ECONOMICS 

opportunities.  Full  knowledge  of  the  relative  advantages  of 
different  occupations,  of  different  employments,  of  different 
investment  opportunities,  of  different  fields  for  business  enter- 
prise, would  always  have  to  exist.  Consumers,  too,  would  have 
to  be  always  alert  to  take  advantage  of  any  slight  differences 
in  the  prices  of  competing  producers,  or  in  the  quality  of  their 
goods  and  services.  Moreover,  their  tastes  and  preferences 
with  regard  to  the  things  they  consume  would  have  to  be 
constant,  or  at  most  could  change  but  slowly.  Similarly,  the 
introduction  of  new  inventions  and  other  new  ways  of  produc- 
ing things  must  be  ruled  out. 

In  short,  if  economic  activity  were  sheer  routine;  if  each 
business  man,  hard  pressed  by  an  alert  and  well-informed 
competition,  had  no  opportunity  before  him  except  to  produce 
standardized  products  for  a  dependable  market,  pure  profits 
would  be  quite  impossible.  The  able  business  man  could  get  a 
larger  income  than  his  fellows  only  by  getting  a  larger  product 
for  a  given  expense  for  labor,  capital,  and  land.  Paying  the 
same  prices  for  these  productive  agents  as  his  competitors, 
selling  the  same  kinds  of  products  at  prices  identical  with  theirs, 
only  as  he  gets  a  larger  product  for  a  given  expense,  only,  that 
is,  as  he  is  a  more  efficient  manager,  can  his  gains  be  larger  than 
theirs.  His  profits  are  limited  to  his  wages  of  management. 
So  smoothly  and  perfectly  would  the  routine  of  the  economic 
process  operate  that  there  would  be  no  field  for  what  is,  in 
reality,  merely  another  name  for  profit  seeking,  —  business 
enterprise. 

The  Sources  of  Pure  Profits.  —  Pure  profits  exist  because 
competition  does  not  work  perfectly ;  because  people  do  not 
always  know  and  are  not  always  alert  to  seize  the  most  ad- 
vantageous course  open  to  them  either  as  producers  or  as  con- 
sumers ;  because  there  are  such  things  as  fads  and  fashions  and 
changes  in  the  quantity  and  quality  of  wants;  because  the 
system  of  competitive  prices  is  not  a  thoroughly  consistent 
structure ;  because,  in  short,  room  is  left  for  business  enterprise. 

Take,  for  example,  a  very  simple  case.  A  owns  a  house, 
which  he  is  willing  to  sell  for  $5000.     B  is  willing  to  pay  $6000 


PROFITS  529 

for  just  such  a  house,  but  neither  A  nor  B  knows  the  other  or 
the  other's  position  as  a  buyer  or  seller.  C,  knowing  the  situa- 
tion, buys  from  A  for  $5000  and  sells  to  B  for  $6000,  gaining  a 
profit  of  $1000  for  himself.  This  profit,  it  is  obvious,  is  made 
possible  only  by  the  lack  of  complete  knowledge  of  the  situation 
on  the  part  of  A  and  B.  The  transaction  is  without  risk  to  C, 
who  merely  takes  advantage  of  this  specific  instance  of  the 
general  fact  that  for  many  classes  of  goods  competition  fails  to 
set  a  definite  market  price. 

Next,  assume  that  the  purchaser,  B,  has  bought  the  house 
merely  for  the  sake  of  selling  it  again,  if  possible,  at  a  profit. 
He  may  have  reason  to  believe  that  there  will  be  an  increase  in 
the  demand  for  houses  or  in  the  expense  of  building  them,  so 
that  he  counts  on  finding  a  buyer  who  will  pay  more  than 
$6000  for  the  house.  If  he  succeeds,  it  will  be  because  the 
general  market  situation,  so  far  as  houses  are  concerned,  will 
have  changed  in  accordance  with  his  own  forecasts.  He  takes 
the  risk  of  loss,  but  this  does  not  mean  that  he  is  blindly  "  tak- 
ing a  chance."  On  the  basis  of  present  facts  he  reaches  certain 
conclusions  or  judgments  with  respect  to  future  probabilities. 
He  cannot  eliminate  risk,  but  can  select  what  seems  to  him  to 
be  a  favorable  opportunity.  His  profits  —  if  he  gets  them  — 
are  to  him  the  result  of  successful  risk-taking. 

These  two  methods  of  getting  profits,  employed  by  C  and  B, 
respectively,  indicate  the  two  general  sources  of  profits:  (1)  in- 
consistencies, incomplete  adjustments,  in  the  general  price 
situation  as  it  exists  at  any  one  time ;  (2)  changes  in  the  general 
price  situation.  But  (3)  in  most  business  operations  these  two 
sources  of  profits  are  blended.  And  yet  there  are  many  trans- 
actions which  are  like  those  suggested  in  our  illustration  in  that 
profits  are  derived  entirely  from  one  source  or  from  the  other. 

1.  We  shall  consider  first  those  transactions  in  which  buying 
at  one  price  and  selling  at  another  are  for  the  profit-seeker 
practically  simultaneous  operations.  Risk,  on  the  individual 
transaction,  is  eliminated.  But  there  remains  the  risk  that,  if 
one  makes  this  type  of  profit-seeking  one's  vocation,  one's 
aggregate  gains  may  not  amount  to  enough  to  compensate 


530  OUTLINES  OF  ECONOMICS 

one  for  one's  incidental  expenses  and  for  the  use  of  one's 
time. 

Profits  of  this  kind  are  found  in  many  real  estate  operations, 
in  some  transactions  conducted  by  brokers  in  different  fields, 
in  arbitrage  transactions  in  foreign  exchange  or  securities  or 
produce,  and,  naturally,  in  a  large  variety  of  miscellaneous 
isolated  transactions.  There  is  no  reason  to  believe  that  the 
aggregate  amount  of  pure  profits  of  this  sort  is  large.  Where 
large  margins  may  exist  between  buying  and  selling  prices 
(as  in  the  case  of  land,  works  of  art,  and  other  non-reproducible 
goods)  or  where  the  aggregate  volume  of  transactions  is  so 
great  as  to  make  even  small  differences  in  prices  significant, 
intermediaries  and  go-betweens  multiply,  and  competition 
tends  to  pull  their  (annual)  profits  down  to  an  entrepreneur's 
wage,  or  less. 

2.  More  important  as  an  independent  source  of  profits  is  the 
difference  between  the  price  situation  at  any  one  time  and  the 
price  situation  at  some  later  time.  A  very  common  profit- 
seeking  operation  consists  of  buying  things  now  in  the  hope  of 
selling  them  at  a  higher  price  in  the  future,  or  of  selling  things 
now  (for  future  delivery)  with  the  expectation  of  securing  them 
at  a  lower  price  in  the  future.  The  larger  part  of  "  specula- 
tion ;'  in  real  estate,  in  produce,  and  in  securities,  is  profit- 
seeking  of  precisely  this  type. 

Risk  always  attends  such  operations.  The  speculator  may 
prove  to  have  been  mistaken  in  his  analysis  of  the  general 
situation,  or  new  and  unforeseen  factors  may  enter.  Prices 
may  move  in  a  direction  opposite  to  that  on  which  the  speculator 
had  counted,  and  losses  rather  than  profits  may  result.  This 
may,  for  example,  be  caused  by  competition  in  profit-seeking. 
Other  speculators  will  in  most  cases  have  seen  the  same  op- 
portunity for  profits.  By  buying  now  in  large  quantities  for 
speculative  purposes  they  are  sure  to  increase  present  prices. 
Similarly,  by  selling  at  a  later  date  they  are  equally  certain  to 
make  prices  then  lower  than  they  otherwise  would  have  been. 
The  chief  economic  service  of  speculation,  in  fact,  lies  in  its 
tendency  to  lessen  fluctuations  in  prices.     But  the  thing  may 


PROFITS  531 

be  overdone :  future  prices  may  be  forced  down  to  a  point 
where  the  expected  profits  are  turned  into  losses.  And,  mutatis 
mutandis,  the  same  considerations  hold  true  of  "  bear  "  opera- 
tions, on  the  other  side  of  the  market.  The  possibility  of  being 
caught  in  a  price  movement  of  this  sort,  resulting  from  over- 
speculation,  is  one  of  the  ordinary  risks  of  this  kind  of  profit- 
seeking. 

3.  In  most  cases,  as  we  have  said,  the  two  general  sources  of 
profits  are  blended.  The  great  mass  of  business  transactions 
are  not  so  simple  as  those  we  have  just  considered.  Profits 
are  sought,  not  merely  by  buying  one  thing  and  then  selling 
it,  either  immediately  or  at  some  other  time,  but  also,  and 
more  generally,  by  buying  certain  things  and  then  using  them, 
combining  them,  in  such  a  way  as  to  get  a  new  salable  product, 
or  at  least  a  product  to  which  new  qualities  have  been  added. 
Returning  to  the  illustration  of  the  house,  we  may  assume  that 
it  may  have  been  built  to  sell,  and  the  things  bought  were,  in 
the  first  instance,  labor,  building  materials,  and  advances  of 
funds  with  which  to  make  payments.  Or  the  house  might  have 
been  built  by  a  contractor,  who  first  sold  the  house  (for  "  future 
delivery  ")  and  then  bought  the  labor  and  material  and  advances 
necessary  for  its  construction.  And  so  in  agriculture,  manu- 
factures, and  commerce  generally :  the  entrepreneur  buys  some 
things  —  labor,  land  or  its  use,  capital  goods  in  various  forms, 
advances  of  loanable  funds  —  and  sells  other  things  —  the 
commodities  or  services  that  are  his  "  products." 

The  inconsistencies  and  maladjustments  in  the  general  price 
situation  of  which  he  tries  to  take  advantage  are,  in  short,  the 
differences  between  the  prices  he  has  to  pay  for  the  things  he 
uses  in  making  and  selling  his  products  and  the  prices  he  gets 
for  his  products.  If  competition  worked  with  absolute  prompt- 
ness, smoothness,  and  efficiency,  things  would  sell  at  prices 
equal  to  their  expenses  of  production,  and  the  most  the  entre- 
preneur could  get  would  be,  as  we  have  seen,  his  entrepreneur's 
wage. 

The  time  element,  involving  the  possibility  of  gains  (or  losses) 
from  price  changes,  also  enters  in,  because  most  of  the  expenses 


532  OUTLINES  OF  ECONOMICS 

of  production  are  incurred  either  before  or  (in  the  case  of  con- 
tracts for  future  delivery)  after  the  price  which  can  be  got  for 
the  product  is  finally  determined.1 

Marginal  Productivity  and  Profits.  —  In  our  discussion  of  the 
law  of  diminishing  productivity  2  we  took  no  account  of  pure 
profits.  We  saw  that  in  any  undertaking  a  definite  part  of 
the  product  had  to  be  imputed  or  attributed  to  each  productive 
agent,  and  further,  that  the  amount  of  product  so  attributed  to 
any  unit  of  a  productive  agent  was  the  amount  dependent  upon 
the  use  of  that  particular  unit.  But  this  does  not  mean  that  in 
any  undertaking  the  sum  of  those  parts  of  the  product  which 
have  to  be  imputed  to  particular  productive  agents  will  exhaust 
the  whole  product.  Moreover,  it  is  not  wholly  correct  to 
think  of  the  product  as  being  created  by  the  "  application  "  of 
labor  and  capital  to  land  or  of  land  and  capital  to  labor. 

In  any  business  undertaking,  the  one  thing  always  given  or 
fixed  (at  any  one  time)  is  the  general  object  of  the  undertaking, 
the  business  scheme,  the  productive  or  acquisitive  plan  of  the 
entrepreneur.  In  carrying  out  his  plans,  in  securing  a  product 
and  a  market  for  it,  the  entrepreneur  has  to  utilize  productive 
agents.  In  combining  them,  in  applying  tJiem  to  his  general 
profit-seeking  plan,  he  encounters  the  law  of  diminishing  produc- 
tivity, and,  normally,  pushes  each  particular  kind  of  expenditure 
up  to  the  marginal  point.  If  he  is  successful  there  will  be  a 
surplus  over  and  above  his  aggregate  expenses.  That  is,  his 
total  product  will  more  than  cover  the  "  specific  products  " 
that  have  to  be  imputed  to  the  various  productive  agents  he 
utilizes.'    This  surplus,  of  course,  is  his  profits.3 

1  Entrepreneurs  are  often  able  to  eliminate  or  shift  part  of  this  price-fluctuation 
element  in  profits  (with  its  accompanying  chance  of  loss).  The  building  contractor 
may,  for  example,  contract  for  his  materials  when  he  enters  into  a  contract  to  build 
a  house.  Manufacturers  of  flour  and  of  cotton  goods,  as  well  as  grain  and  cotton 
buyers,  are  able  largely  to  shift  the  risk  of  price  fluctuations  to  professional  specula- 
tors by  means  of  the  process  known  as  "hedging,"  which  will  be  described  in  Chapter 
xxix. 

1  See  Chapter  xix. 

'  Although  the  present  chapter  is  concerned  only  with  profits  in  competitive 
undertakings,  this  analysis  of  the  relation  of  profits  to  the  law  of  marginal  produc- 
tivity holds  true  also  of  monopoly  Drofit1*. 


PROFITS  533 

Profits  for  the  Industry  and  Profits  for  the  Establishment.  — ■ 
We  must  note  at  this  point  an  important  difference  between 
the  production  of  standardized  goods  —  where  one  establish- 
ment's product  is  like  another's  —  and  the  production  of  goods 
or  services  which  are  marked  off  or  distinguished  as  the  output 
of  particular  establishments. 

In  agriculture,  for  example,  standardized  products  are  pro- 
duced for  a  general  market.  If  certain  farmers  make  larger 
incomes  than  their  neighbors  it  is  generally  because  they  are 
more  efficient  farmers  and  earn  a  larger  entrepreneur's  wage. 
This  may  show  itself  in  two  ways.  First,  a  good  farmer  will 
get  a  larger  product  with  a  given  expenditure.  He  will  appor- 
tion and  use  his  productive  agents  to  better  advantage.  Sec- 
ond, because  he  gets  a  larger  product  by  means  of  a  given 
expenditure,  he  will  be  able  to  push  his  expenditures  further 
before  coming  to  the  margin  beyond  which  it  will  not  pay  him 
to  go.  That  is,  he  can  advantageously  "  farm  on  a  larger 
scale  "  than  his  less  efficient  neighbors.  But  while  these  ad^ 
vantages  increase  his  entrepreneur's  wage,  they  do  not,  in 
themselves,  create  pure  profits. 

If  the  farmer  gets  pure  profits  it  is  because  he  has  successfully 
tried  some  new  crops  or  some  new  methods,  or  because  he  has 
been  individually  fortunate  in  some  other  way,  or  because 
he  and  other  farmers  have  been  able  to  sell  their  crops  at 
profitable  prices.  This  last  point  is  the  important  one.  In 
agriculture  and  other  industries  producing  standardized  prod- 
ucts for  a  general  market,  by  far  the  most  important  profits 
(and  losses)  are  those  which  come  to  the  industry  as  a  whole. 
Except  for  the  effect  of  such  things  as  local  droughts  or  frosts 
or  blights,  when  the  wheat  growers  of  the  country  prosper  they 
prosper  together,  and  when  they  lose  they  lose  together,  — 
and  so  with  the  corn  growers  and  the  tobacco  growers  and  the 
cotton  growers.  Wars,  tariffs,  crop  failures  abroad,  —  these 
and  other  things  like  these  will  affect  the  demand  for  their 
products.  The  supply  will  depend  in  part  upon  weather  con- 
ditions, but  more  largely  upon  the  amount  of  these  crops  that 
farmers  as  a  group  have  thought  it  worth  while  to  plan  to  grow. 


534  OUTLINES  OF   ECONOMICS 

These  conditions  of  supply  and  demand  are  absolutely  beyond  the 
control  of  any  one  individual  producer.  A  succession  of  profit- 
able years  is  sure  to  result  in  an  increased  output,  with  lower 
prices  and  lower  profits.  In  agriculture,  as  everywhere,  there 
are  rewards  for  the  efficient  and  energetic  producer,  but,  with 
minor  exceptions,  his  chances  of  getting  pure  profits  are  de- 
pendent upon  the  fortunes  of  the  industry  as  a  whole. 

In  the  fields  in  which  each  entrepreneur  can  mark  off  his 
product  or  his  establishment  as  his  own,  we  find  a  very  different 
situation.  The  manufacturer  or  jobber  who  can  in  some  way 
identify  his  products  by  special  brands,  and  the  retailer,  deal- 
ing directly  with  the  consumer,  are  able  to  secure  pure  profits 
(and  to  run  the  risk  of  corresponding  losses)  on  their  individual 
undertakings,  over  and  beyond  such  profits  and  losses  as  may 
come  from  general  business  fluctuations. 

Here  also  the  entrepreneur  is  limited  by  the  law  of  diminish- 
ing productivity,  and  here  also  he  normally  pushes  his  expen- 
ditures of  all  kinds  up  to  the  margin.  And  (if  he  is  his  own 
manager)  he  will  get  a  larger  or  smaller  entrepreneur's  wage 
according  as  he  can  get  a  larger  or  smaller  product  per  unit  of 
expense.  But  many  of  his  expenses  will  be  what  we  have 
called  "  competitive  investments,"  that  is,  they  will  be  devoted 
to  creating  a  market  for  his  products  rather  than  to  creating 
the  products.  The  quantities  that  he  can  profitably  produce 
and,  within  limits,  the  prices  he  can  charge,  will  be  determined 
very  largely  by  his  success  in  inducing  purchasers  to  prefer 
his  goods  or  his  store  to  others.  The  profits  of  cotton  growers 
are  directly  conditioned,  as  we  have  seen,  by  the  aggregate 
demand  for  cotton  and  the  aggregate  supply  of  cotton.  But 
with  the  retail  dealer  and  with  the  manufacturer  of  breakfast 
foods  or  canned  fruits  or  clothes  or  soap  or  motor  cars  or  foun- 
tain pens  or  almost  any  other  kind  of  branded  merchandise, 
profits  depend  very  largely  upon  the  preference  of  consumers 
for  one  store  or  for  one  make  of  goods.  The  getting  of  profits 
is  not  merely  a  matter  of  indirect  competition  among  indus- 
tries ;  it  is  a  matter  of  direct  competition  among  individual 
establishments.     One  competitor  may  gain  while  others  in  the 


profits  535 

same  field  are  losing,  and  may  gain  even  in  the  face  of  a  gener- 
ally unprosperous  condition  of  business. 

Good-will.  —  It  very  often  happens  that  the  entrepreneur 
who  has  developed  his  business  to  a  profitable  point  is  able  to 
attach  some  degree  of  permanency  to  his  profits.  A  merchant 
often  relies  to  a  very  considerable  extent  upon  the  patronage 
of  an  established  clientele  of  customers,  and  he  in  turn  may 
prefer,  other  things  being  equal,  to  purchase  his  goods  from 
particular  wholesale  houses.  Manufacturers  and  wholesalers^ 
too,  try  to  build  up  a  habitual  preferential  demand  for  their 
products.  When  a  business  undertaking  is  sold  as  a  whole, 
its  established  connections  of  this  sort  enter  into  the  price  paid 
for  it,  under  the  head  of  "  good-will."  This  good-will  element 
is  generally  measured  by  the  difference  between  the  selling  value 
of  the  business  as  a  whole  and  the  selling  value  imputed  or 
ascribed  to  its  specific  assets  in  the  form  of  capital  goods  and 
accounts  receivable  (minus  its  specific  liabilities).  In  the  sale 
of  a  newspaper  it  often  happens  that  its  good-will  (its  established 
advertising  and  subscription  patronage)  is  the  only  thing  ac- 
tually transferred.  This  does  not  mean,  however,  that  the 
selling  price  of  the  good-will  of  an  establishment  necessarily 
corresponds  to  a  capitalization  of  its  pure  profits.  The  good- 
will may  be,  in  individual  cases,  very  much  less  than  the  aggre- 
gate amount  of  the  expenses  incurred  in  the  past  in  the  effort 
to  build  it  up.  And  when  once  sold  at  a  fair  price,  the  purchaser 
acquires  no  peculiar  power  of  getting  unusual  profits.  For  him 
the  price  paid  for  good-will  is  an  investment,  and  he  has  to 
deduct  interest  on  the  investment  before  he  can  count  his  in- 
come as  profits.  In  short,  he  has  to  start  afresh,  with  no 
differential  advantage. 

Good- will  is  to  be  attributed,  in  large  measure,  to  the  economic 
inertia  and  friction  which  result  from  the  fact  that  buyers  are 
guided  to  a  very  large  extent  by  custom  and  habit  rather  than  by 
conscious  choice.  However,  in  many  small  transactions,  for 
customers  to  attempt  to  buy  always  at  the  lowest  price  would 
result  in  a  waste  of  time  and  energy  disproportionate  to  the  gain. 
Hence,  aside  from  the  influence  of  custom  and  habit,  there  may 


536  OUTLINES   OF   ECONOMICS 

often  be  rational  ground  for  the  continued  patronage  of  particular 
establishments  and  the  continued  purchase  of  particular  goods 
which  customers  have  found  to  be  trustworthy. 

The  Relation  of  Risks  to  Profits.  —  Profits  differ  from  other 
forms  of  income  in  the  degree  to  which  they  are  contingent 
upon  successful  risk  taking.  But  risk  taking,  in  this  sense,  as 
we  have  seen,  does  not  mean  a  blind  dependence  on  chance. 
Chance  is,  of  course,  an  element  in  profits.  Capricious  changes 
in  fashion  often  bring  temporarily  high  profits  to  dealers  who 
happen  to  have  the  right  kinds  of  goods  in  stock,  or  to  manu- 
facturers who  happen  to  have  the  equipment  needed  to  produce 
the  right  kinds  of  goods.  And  other  examples  will  suggest  them- 
selves to  the  reader.  But  there  are  chance  losses  as  well  as 
chance  gains,  and  there  is  no  reason  to  believe  that  they  are 
not  quite  as  numerous  and  important.  Chance  gains,  therefore, 
do  not  constitute  any  important  part  of  the  income  going  to 
entrepreneurs  as  a  class,  but  they  may  often  be  a  considerable 
element  in  the  profits  of  a  particular  entrepreneur. 

Risk  taking  is  nearly  synonymous  with  business  enterprise. 
It  involves  careful  estimates  of  the  amounts  of  product  that  can 
be  got  from  different  combinations  of  labor,  capital,  and  land, 
and  equally  careful  estimates  of  the  salability  of  such  products. 
It  is  in  this  latter  field,  which  involves  the  diagnosis  of  market 
conditions  with  a  view  to  ascertaining  their  probable  trend,  as 
well  as  the  possibility  of  affecting  them  to  his  advantage,  that 
an  entrepreneur's  skill  finds  its  chief  opportunity.  Yet,  though 
he  may  deal  with  probabilities  rather  than  with  possibilities,  he 
is  nevertheless  a  risk  taker.  His  estimates  have  to  do  with  mar- 
ket conditions  that  are  often  entirely  beyond  his  personal 
control,  and  which,  at  best,  he  can  influence  only  by  efforts 
directed  to  that  end,  —  by  expenditures  that  may  prove  to  have 
been  wasted. 

To  anticipate  consumers'  demands  correctly  is  not  in  itself  a 
guarantee  of  profits  to  any  entrepreneur.  If  other  entrepreneurs 
have  counted  on  the  same  demand,  it  may  easily  happen  that  the 
total  product  cannot  be  sold  at  a  profitable  price.  In  fact,  the 
"  market  conditions  "  which  the  entrepreneur  has  to  forecast 


profits  537 

include  the  conditions  of  supply  as  well  as  of  demand.  But  even 
in  case  a  given  entrepreneur  has  succeeded  in  producing  the 
precise  things  that  consumers  are  demanding  and  other  entre- 
preneurs are  not  producing,  and  has  thus  been  able  to  get  large 
profits,  he  cannot  count  on  their  permanence.  Demand  may 
change,  but  even  if  demand  remains  constant  or  increases,  his 
large  profits  will  be  a  standing  invitation  to  other  entrepreneurs 
to  enter  the  same  field,  —  a  condition  which  will  continue  until 
competition  forces  the  profits  of  this  particular  kind  of  business 
down  to  where  they  just  suffice  to  pay  the  wages  of  management. 
If  the  product  can  be  marked  off,  or  distinguished  in  some  way, 
good-will  may  be  built  up,  as  we  have  seen,  so  as  to  give  some 
degree  of  permanency  to  profits.  But  even  here  the  entre- 
preneur has  to  guard  against  the  inroads  of  other  business  men, 
seeking  to  win  trade  for  their  own  products.  In  some  few  cases 
profits  are  secured  without  risk ;  some  (not  all)  kinds  of  risks 
can  be  eliminated  by  insurance  or  shifted  to  some  other  risk 
taker ;  but,  in  general,  profit  seeking  and  risk  taking  go  hand 
in  hand. 

The  Entrepreneur.  —  We  have,  for  convenience,  spoken  of 
"  the  entrepreneur  "  of  an  enterprise.  We  have  also  assumed 
that  general  managership  and  supervision  of  the  undertaking 
is  in  the  entrepreneur's  hands.  But  the  reader  has  been  warned 
that  all  managerial  duties  may  be,  and  often  are,  delegated  to 
salaried  employees,  and  that  the  entrepreneur  may  also  be 
capitalist,  landlord,  and  laborer.  Most  American  farmers  are 
all  three.  And  most  entrepreneurs  in  other  fields  supply  a  part 
of  their  own  investment  funds.  But  who,  in  a  particular 
enterprise,  is  "  the  entrepreneur  "  ? 

The  entrepreneur  is  the  "  business  man,"  as  distinguished 
from  the  capitalist,  the  laborer,  or  the  landowner.  He  is,  more 
specifically,  the  one  who  profits  if  a  business  undertaking  suc- 
ceeds and  who  loses  if  it  fails.  Now  it  is  clear  that  more  than  one 
person  may  lose  if  a  business  undertaking  fails,  —  or  others  than 
the  common  stockholders,  often  regarded  as  "  corporate  entre- 
preneurs," if  the  business  is  incorporated.  Bondholders,  other 
creditors,  laborers  even,  may  also  lose.     The  fact  that  the  bond- 


538  OUTLINES   OF   ECONOMICS 

holders  are  preferred  creditors  may  limit  their  losses,  but  does  not 
necessarily  safeguard  them  from  losing.  The  fact  is  that  every 
one  who  has  risked  something  on  the  success  or  failure  of  a  par- 
ticular business  undertaking  is,  in  that  degree,  entrepreneur. 
The  capitalist  who  buys  5^-  per  cent  bonds  instead  of  virtually 
riskless  3^  per  cent  bonds,  or  who  buys  7  per  cent  preferred  stock 
at  par,  the  money  lender  who  has  no  security  other  than  the  pro- 
spective earnings  of  the  business,  the  laborer  who  chooses  a  well- 
paid  but  uncertain  employment  to  a  surer  but  lower-paid  one, 
are  all  profit-seekers.  If  the  business  undertakings  in  which 
they  thus  cooperate  succeed,  they  share  in  the  profits,  up  to 
a  stated  amount;  if  these  undertakings  fail,  these  various  co- 
operators  lose,  in  larger  or  smaller  amount.  Their  profits,  if 
they  get  them,  are  surpluses  over  costs,  the  costs  being  meas- 
ured by  the  interest  and  wages  that  they  could  have  obtained 
in  virtually  safe  alternative  employments.  Wherever  in  eco- 
nomic life  one  finds  successful  risk  taking,  there  one  finds  profits. 
The  "  individual  entrepreneur  "  and  the  holder  of  common 
stock  merely  assume  a  relatively  larger  burden  of  risk;  have 
the  opportunity  of  reaping,  in  case  of  success,  •  correspond- 
ingly larger  profits;  and  usually  exercise  a  correspondingly 
larger  measure  of  responsible  direction  of  the  policies  of  the 
undertaking. 

Profits  and  the  Justification  of  the  Competitive  System.  — 
It  is  the  desire  to  get  money  profits  that  leads  entrepreneurs  to 
produce  particular  things  and  to  produce  them  in  particular 
ways.  It  is  for  this  reason  that  old  channels  of  productive 
effort  are  continually  being  abandoned,  and  that  the  use  of 
labor,  capital,  and  land  is  continually  being  guided  into  new 
channels.  The  shifting  of  productive  effort  which  the  pursuit 
of  money  profits  involves  consists,  for  the  most  part,  of  efforts 
on  the  part  of  entrepreneurs  to  meet  the  shifting  wants  of 
consumers. 

One  of  the  strongest  arguments  for  the  superiority  of  the  com- 
petitive system  over  any  possible  substitute  for  it  lies  in  the  claim 
that,  under  competition,  the  guiding  of  production  into  the 
channels  indicated  by  the  search  for  money  profits  will  result  in 


PROFITS  539 

the  maximum  satisfaction  of  human  wants.  This  seems  to 
follow  from  the  fact  that  the  prices  people  are  willing  to  pay  for 
certain  commodities  measure  the  importance  which  they  attach 
to  the  possession  of  those  commodities.  The  shifting  of  labor 
and  capital  from  less  profitable  to  more  profitable  uses  means,  in 
general,  that  more  intense  wants  will  be  satisfied  with  the  same 
expenditure  of  productive  energy.  All  this  is  implied  in  the 
statement  made  above  that  the  shifting  of  productive  effort 
is  mainly  in  response  to  the  changing  wants  of  consumers.  This 
argument,  that  under  free  competition  the  pursuit  of  money 
profits  leads  to  the  best  adaptation  of  productive  efforts  to  the 
satisfaction  of  the  wants  of  consumers,  is  one  that  has  rarely 
been  squarely  met  by  those  who  attack  the  competitive  system. 
There  are,  however,  several  important  considerations  that  lessen 
to  some  extent  its  force. 

In  the  first  place,  the  extent  to  which  the  wants  of  any  indi- 
vidual affect  the  ordering  of  the  productive  process  depends 
upon  his  purchasing  power,  that  is,  primarily,  upon  his  income. 
It  is  manifestly  absurd  to  say  that  the  shifting  of  labor  and  capi- 
tal from  the  production  of  necessities  for  the  poor  to  the  produc- 
tion of  luxuries  for  the  rich,  simply  because  it  may  be  more 
profitable,  necessarily  means  a  better  satisfaction  of  human 
wants.  The  extent  to  which  wants  are  satisfied  depends  on  the 
way  wealth  is  distributed,  as  well  as  upon  the  amount  and 
kinds  of  things  produced. 

Moreover,  even  granting  that  the  stimulus  of  money  profits 
leads  to  the  best  practicable  satisfaction  of  the  wants  of  presc  t 
consumers,  this  may  sometimes  be  achieved  by  imposing  added 
difficulties  in  want-satisfaction  on  future  generations.  The 
lines  of  procedure  that  will  bring  maximum  profits  to  entre- 
preneurs sometimes  run  counter  to  the  more  permanent  in- 
terests of  society.  We  all  recognize,  for  example,  that  there 
may  be  such  a  thing  as  a  too  rapid  exploitation  of  natural 
resources.  The  history  of  timber  lands  in  America  furnishes  an 
instructive  example. 

A  still  more  important  qualification  of  the  statement  that  com- 
petitive profit  seeking  works  for  the  best  interests  of  society. 


540  OUTLINES   OF   ECONOMICS 

viewed  as  a  body  of  consumers,  is  found  in  the  fact  that  when, we 
begin  to  speak  of  the  interests  of  society,  we  introduce,  of  neces- 
sity, the  ethical  point  of  view.  This  means  that  we  must  con- 
sider not  only  the  quantity  but  also  the  quality  of  want-satisfac- 
tions. For  purposes  of  the  economic  analysis  of  market  forces, 
we  make  no  distinction  between  different  kinds  of  wants,  but 
it  is  impossible  to  discuss  social  well-being  without  taking  into 
account  the  fact  that  from  the  point  of  view  of  the  interests  of 
society  some  kinds  of  want-satisfactions  are  good  and  some  are 
bad,  and  that  even  the  better  kinds  of  want-satisfactions  vary 
greatly  in  their  importance,  when  measured  by  any  rational 
criterion  of  social  welfare.  The  production  of  socially  undesir- 
able things,  such  as  intoxicating  liquors,  adulterated  foods, 
ill-ventilated  tenements,  etc.,  is  often  prohibited,  while,  on  the 
other  hand,  society  has  found  that  certain  socially-desirable 
things,  such  as  schools,  parks,  libraries,  clean  streets,  etc.,  will 
not  be  supplied  at  all,  or  will  not  be  supplied  in  sufficient 
quantities  by  private  business  enterprise.  All  indications  point 
to  a  very  considerable  extension  of  organized  social  activity  at 
precisely  those  points  where  the  private  pursuit  of  money  profits 
has  proven  itself  inadequate. 


QUESTIONS 

i.  Are  profits  as  defined  in  accounting  identical  with  profits  as  defined  in 
economics? 

2.  Is  there  a  sense  in  which  pure  profits  can  be  said  to  be  a  reward  for 
productive  services?  If  so,  should  they  be  counted  among  the  expenses  of 
production  ? 

3.  In  what  way  are  the  profits  of  a  retailer  attributable  to  "incon- 
sistencies and  maladjustments  in  the  price  situation"? 

4.  Does  a  monopolist  push  his  expenditures  of  all  kinds  up  to  the  marginal 
point? 

5.  What  industries,  aside  from  agriculture,  produce  "standardized  prod- 
ucts for  a  general  market "  ? 

6.  Some  economists  speak  of  the  "profits  on  capital."  Others  speak  of 
profits  as  income  secured  by  personal  exertions.  Which  form  of  statement  is 
correct?     Are  the  two  necessarily  inconsistent? 

7.  Is  good-will  capital? 

8.  If  there  were  no  economic  risks,  would  profits  be  possible? 


PROFITS  541 

REFERENCES 

Carver,  T.  N.    Distribution  of  Wealth,  Chap.  vii. 

Clark,  J.  B.     Distribution  of  Wealth,  Chap.  vi. 

Hawley,  F.  B.     Enterprise  and  the  Productive  Process. 

Hayxes,  John.     "Risk  as  an  Economic  Factor."     Quarterly  Journal  of 

Economics,  Vol.  ix,  pp.  409-449. 
Marshall,  Alfred.     Principles  of  Economics,  6th  ed.,  Book  vi,  Chaps. 

vii,  viii. 
Veblex,  Thorstein.     Theory  of  Business  Enterprise,  Chap.  iii. 


CHAPTER  XXVI 
THE   PERSONAL   DISTRIBUTION   OF   WEALTH 

In  the  present  chapter  we  shall  study  the  distribution  of 
wealth  and  income  among  individuals  simply  as  individuals, 
and  not  as  agents  of  production  or  owners  of  productive  agents. 
What  is  the  cause  of  large  fortunes?  Is  the  middle  class  dis- 
appearing? Can  we  abolish  poverty?  To  begin  with,  certain 
distinctions  must  be  clearly  drawn. 

Wealth  and  Income.  —  The  distribution  of  wealth  and  in- 
come should  first  be  distinguished  from  the  distribution  of  final 
consumption.  We  may  have  in  mind  simply  the  enjoyment 
of  material  things  and  services.  A  man  of  vast  possessions 
may  be  very  frugal  in  his  consumption,  acting  with  respect  to 
most  of  his  property  simply  as  a  trustee  for  society.  But  when 
we  are  interested  in  social  classes,  industrial  democracy,  and 
personal  power  and  independence,  the  distribution  of  wealth  or 
income  is  important,  no  matter  how  frugal  the  owners  of  large 
wealth  may  be. 

Absolute  and  Relative  Well-being.  —  Two  entirely  independ- 
ent inquiries  are  very  frequently  confused,  (i)  We  may  wish 
to  know  whether  the  condition  of  the  mass  of  the  people  is  get- 
ting better  or  worse.  Do  they  have  more  or  less  of  the  good 
things  of  life  than  their  ancestors  had?  But  we  may  also  ask, 
(2)  What  share  of  the  total  product  of  industry  is  received  by 
each  section  of  the  community?  Which  section  is  gaining  upon 
the  others?  If  A  and  B  divide  a  catch  of  ten  fish  equally  to- 
day, and  if  to-morrow  A  gets  ten  out  of  a  total  catch  of  thirty, 
then  absolutely  his  income  has  increased,  but  relatively  it  has 
declined. 

Concentration  of  Wealth  and  Large-scale  Production.  —  It  is 
perhaps  worth  while  to  warn  the  reader  against  confusing  the 

542 


THE   PERSONAL   DISTRIBUTION  OF  WEALTH 


543 


question  of  large  and  small  fortunes  with  the  question  of  large 
and  small  scale  production.  However  improbable,  it  is  at  least 
conceivable  that  there  might  be  an  equality  of  property  with 
production  carried  on  largely  as  it  is  today,  for  we  have  but  to 
imagine  an  equal  distribution  of  holdings  of  stocks  and  other 
equities  in  business  enterprise. 

Methods  of  Measuring  Concentration  of  Wealth  and  Income. 
—  How  shall  we  tell  whether  the  middle  class  is  tending  to  dis- 
appear ?  A  common  method  is  to  make  a  classification  of  wealth 
and  income,  and  then  to  compare  the  number  of  persons  in 
each  class  at  different  dates.  The  unreliability  of  the  conclu- 
sions based  on  such  a  procedure  is  made  clear  by  the  following 
hypothetical  illustration :  Let  $100  be  distributed  among  ten 
persons  as  follows:  $i,  $3,  $5,  $7,  $9,  $11,  $13,  $15,  $17,  $19. 
Then  suppose  each  individual's  holding  is  doubled,  thus :  $2, 
$6,  $10,  $14,  $18,  $22,  $26,  $30,  $34,  $38.  Relatively  to  each 
other  they  are  all  in  the  same  position  as  before,  but  by  the 
erroneous  method  of  comparison  referred  to,  there  appears  to 
have  been  a  concentration  because  the  number  in  the  highest 
class  has  increased  most  rapidly : 

TABLE   I 


Class 

Number 

Dollars 

First  Case 

Second  Case 

0  and  less  than  5 

2 

3 
2 

3 

I 

I 

2 

6 

A  satisfactory  method  of  comparing  the  distribution  of  wealth 
at  different  epochs  must  take  account  of  the  changing  significance 
of  fixed  classifications  when  there  has  been  a  change  in  the  per 
capita  wealth.  This  can  be  done  by  observing  what  proportion 
of  the  wealth  is  owned  by  certain  sections  of  the  population, 
such  as  the  poorest  third,  the  middle  third,  or  the  upper  third 


544  OUTLINES  OF   ECONOMICS 

If  a  larger  proportion  of  the  total  wealth  falls  into  the  hands  of 
the  upper  third,  we  may  say  there  is  evidence  of  a  growing  con- 
centration of  wealth.  It  is  clear  that  no  definite  movement  is 
necessarily  discernible  even  when  changes  are  taking  place,  for 
these  changes  may  tend  toward  concentration  in  one  part  of 
society  and  toward  diffusion  in  another. 

Statistics  of  Distribution.  —  There  are  many  investigations 
showing  the  earnings  of  particular  classes  of  workers,  but  in  the 
United  States  there  is  no  reliable  statement  of  the  division  of  the 
national  wealth  or  income  among  all  classes  of  society.  We  can- 
not use  the  property  tax  assessments  for  this  purpose  because  of 
their  inaccuracy,  and  because  of  the  fact  that  one  individual 
may  be  taxed  in  various  jurisdictions.  The  returns  of  the  pro- 
bate courts  have  been  used  as  a  basis  for  a  statement  of  wealth 
distribution  in  the  United  States  on  the  assumption  that  the  dis- 
tribution of  wealth  among  persons  who  die  in  any  year  is  an 
index  of  the  distribution  of  wealth  among  those  who  are  living. 
But  the  incompleteness  of  our  probate  returns  makes  this  method 
also  a  hazardous  one.  The  federal  income  tax  returns  will 
yield  some  valuable  data  regarding  the  number  of  higher  in- 
comes when  the  material  is  properly  tabulated  for  that  purpose. 

Out  of  very  inadequate  material,  however,  Professor  W.  I. 
King  has  constructed  the  estimates  shown  in  Table  II.  His 
figures  indicate,  further,  that  the  richest  2  per  cent  of  the 
families  in  the  United  States  get  about  one  fifth  of  the  aggre- 
gate income,  while  the  poorest  two  thirds  of  the  families  get 
about  39  per  cent  of  the  aggregate  income.  These  estimates 
cannot  be  supposed  to  be  entirely  accurate,  but  the  impression 
they  give  is  undoubtedly  correct  in  its  general  outlines. 

The  growth  of  the  number  of  millionaires  has  been  used  as  an 
evidence  of  growing  wealth  concentration,  but  it  shculd  be 
noted  that  a  growth  of  population  and  wealth  in  a  community 
would  cause  an  increase  in  the  number  of  millionaires,  even  if 
the  relation  between  the  various  classes  remained  the  same. 
Suppose  that  in  1850  there  had  been  in  the  United  States  but 
fifty  millionaires,  that  three  hundred  and  fifty  persons  had  from 
$750,000  to  $1,000,000,  and  that  six  hundred  persons  had  from 


THE   PERSONAL   DISTRIBUTION  OF   WEALTH 


545 


$500,000  to  $750,000.  If  the  population  had  remained  the 
same  and  every  one's  wealth  had  been  doubled,  in  1900  there 
would  have  been  one  thousand  millionaires,  and  if  the  popula- 
tion at  the  same  time  increased  fourfold,  with  the  relations 
among  the  new  population  the  same  as  in  the  old,  we  should 
then  have  four  thousand  millionaires  without  any  tendency 
toward  concentration.  Nevertheless,  the  increase  of  large  for- 
tunes has  been  so  startling  that  in  spite  of  these  considerations 
one  may  perhaps  regard  them  as  an  indication  of  a  growing  con- 
centration of  wealth.  The  lists  of  very  rich  men  published  in 
the  United  States  from  time  to  time  are  instructive  on  this  point. 
In  1820  men  with  a  personal  property  of  $20,000  were  included ; 
in  1846  a  total  property  of  $50,000  was  considered  very  large ; 
in  1855  this  was  doubled ;  in  1892  a  man  had  to  be  a  million- 
aire to  be  considered  very  rich,  and  at  present  one  may  speak 
of  even  a  billionaire. 

TABLE  II 
Distribution  of  Incomes  in  the  United  States:  19101 


Incomes 
JN  Dollars 

Per  Cent  of  Families 

receiving  Less  than 

Stated  Incomes 

Incomes 
in  Dollars 

Per  Cent  of  Families 

receiving  Less  than 

Stated  Incomes 

200 

.07 

1500 

90.31 

300 

1.04 

1800 

93-67 

400 

7.17 

2000 

94.86 

500 

16.70 

2400 

96.18 

700 

38.92 

3000 

97.42 

1000 

6943 

3600 

98.10 

1200 

81.69 

4000 

98-39 

More  satisfactory  statements  can  be  made  for  those  countries 
which  collect  an  income  tax.  The  following  figures  for  1892 
and  1902  are  from  a  table  prepared  by  Professor  Wagner,  in  a 
study  of  the  income-tax  returns  of  Prussia,  and  the  correspond- 
ing figures  for  191 3  have  been  added : 

1  From  W.  I.  King,  Wealth  and  Income  of  the  People  of  the  United  Stales,  p.  228. 


546 


OUTLINES   OF   ECONOMICS 


TABLE  III 

Incomes  in  Prussia:  1892,  1902,  and  19131 


Incomes  in 
Dollars 

Per  Cent  of  Persons 
(Heads  of  Families  or  Self-    . 
Supporting  Individuals) 

Per  Cent  of  Income 
(That  below  $214  is  estimated) 

1892 

1902 

1913 

1892 

1902 

1913 

Below  214  . . . 
214-714  . .. 
714-2261  . . 
2261-7259  . 
7259-23800. 
Over  23800. 

78.18 

18.98 

2-33 

0.41 

0.08 

O.OI 

70.66 
25-83 

2.88 
°-5i 

O.IO 

0.02 

52.49 

42.12 

4-53 

.68 

.14 

.04 

41.21 
30.01 

12.83 
7-37 
4-65 
3-93 

32.97 
34-92 

13.73 
7.84 
S-i3 
5-40 

18.28 

46.25 

15.84 

8.12 

5.62 

5-89 

Absolute 
amounts 
(Total) 

Number 
11,162,000 

Number 
12,813,000 

Number 
15,404,855 

Dollars 

2,309,076,000 

Dollars 
3,039,498,000 

Dollars 
4,736,000,000 

The  great  mass  of  the  people  even  in  1913  were  too  poor  to  pay 
any  income  tax  at  all,  the  minimum  income  taxed  being  $214. 
About  5  per  cent  of  the  population  at  the  top  received  about  one 
third  the  total  income  in  19 13,  but  in  connection  with  such  a 
statement  it  should  be  said  that  even  if  incomes  should  be 
equally  distributed,  the  average  income  per  family,  or  single 
adults,  would  be  very  small.  In  1902  the  average  money 
income  was  $237  and  in  1913  it  had  risen  to  $307.  This 
absolute  increase  in  money  incomes  among  the  poorest  class 
of  the  people  is  shown  in  the  table  in  the  much  smaller  propor- 
tion of  the  population  found  in  the  class  with  incomes  below 
$214  in  1913  than  in  1902.  This  increase  in  money  income 
does  not  necessarily  mean  greater  well-being  or  greater  equal- 
ity, but  the  table  as  a  whole  shows  no  marked  tendency 
toward  a  concentration  of  incomes  in  the  hands  of  the  upper 
classes. 

When  we  turn  from  the  question  of  relative  well-being  to  that 
of  the  actual  condition  of  each  class  taken  by  itself,  we  find  two 
facts  standing  out  prominently:    (1)  the  fruits  of  economic 


1  From  Zeitschrift  des  Prcussichen  Statistischen  Bureaus,  1904,  p.  231,  and  Stalis- 
tisehes  Jahrbuch  fur  den  Prcussischen  Staat,  1913. 


THE  PERSONAL  DISTRIBUTION  OF  WEALTH         547 

progress  have  not  been  confined  to  a  small  class,  but  have  been 
shared  by  the  masses,  and  (2)  a  surprisingly  large  section  of  the 
population  is  still  in  poverty. 

With  respect  to  the  first  fact,  we  may  say  that  in  material 
comforts  the  people  of  this  generation  are  better  off  than  they 
have  ever  been  before.  The  work  of  settlement  in  which  so 
many  of  our  forefathers  engaged  was  laborious  and  exhausting. 
Food  was  often  scarce,  disease  was  rife  in  many  settlements, 
and  the  women  and  children  in  particular  suffered  greatly. 
After  the  wilderness  was  cleared,  there  ensued  a  period  of 
"  rude  plenty."  Food  was  abundant,  but  it  was  coarse  in 
quality  and  restricted  in  variety,  whilst  everything  that 
had  to  be  brought  from  a  distance  was  very  expensive. 
Education  was  difficult  to  secure,  books  scarce,  and  the 
lives  of  most  people  were,  in  the  main,  monotonous  and 
uneventful. 

The  course  of  wages  from  the  middle  of  the  eighteenth  cen- 
tury to  the  year  1905,  and  the  movement  of  prices  from  i860 
to  the  latter  date,  are  given  in  Table  IV  following.  The  figures 
are  not  altogether  comparable,  nor  so  trustworthy  as  could  be 
wished,  but  the  general  impression  which  they  give  is  correct 
for  the  period  covered.  Speaking  generally,  money  wages 
have  steadily  risen,  and  the  hours  of  labor  have  declined,  with 
minor  interruptions,  since  the  colonial  period,  while  prices  have 
fluctuated  irregularly.  This  table  cannot  be  given  in  the  same 
form  for  later  years,  but  a  recent  study  covering  the  period 
from  1890  to  191 2  shows  that  the  purchasing  power  of  hourly 
wages,  although  increasing  from  1890  to  1905,  fell  rapidly 
after  that  date  owing  to  the  rapid  increase  in  prices,  so  that 
an  hour's  wages  purchased  less  in  191 2  than  in  any  previous 
year  of  the  period.  As  the  number  of  hours  per  week  de- 
creased steadily  from  1890  to  191 2,  the  purchasing  power  of 
a  week's  wages  was  only  about  85  per  cent  of  what  it  had 
been  in  1890.  Purchasing  power  here  is  measured  by  retail 
prices  of  food.1 

1  I.  M.  Rubinow,  "The  Recent  Trend  of  Real  Wages,"  American  Economic 
Aeview,  Vol.  iv,  p.  811.     Cf.  the  table  on  p.  341,  above. 


548 


OUTLINES   OF   ECONOMICS 
TABLE   IV 


Wages 

.  Prices,  and 

Hours 

Wages, 

] 

Prices,  and  Hours  of  L 

IN    i860  TAKEN  AS    I  CO 

\BOR 

of  Labor  in  1890 

AS    IOO 

TAKEN 

Day  Laborers  in 
Massachusetts  l 

Employees  in  Manufacturing 
Industries  —  Eastern  States 

General  Industry,  excluding 

Agriculture,  Mining,  and 

Transportation 

Rela- 
tive 

Year 

Relative 

Year 

Relative 

Period 

Cost 

Hours 

Hears 

Wages 

Wages1 

of 
Living2 

of 
Labor3 

Wages4 

Prices5 

of 
Labor* 

1752-60 

.29 

i860 

100 

IOO 

IOO 

1881 

95-3 

"4-5 

103 

1761-70 

•325 

1861 

IOO 

III 

99.I 

1882 

96.9 

H7-5 

103 

1771-80 

•376 

1862 

100 

123 

98.2 

1883 

97-7 

114-8 

io3 

1781-90 

.428 

1863 

109 

137 

98.2 

1884 

98.5 

107.7 

103 

1791-00 

.623 

1864 

120 

163 

98.2 

1885 

97-8 

100.8 

103 

1801-10 

.817 

1865 

141 

J75 

97-3 

1886 

97.8 

99.6 

102 

181 1-20 

.910 

1866 

*53 

172 

98.2 

1887 

98.6 

100.3 

IOO 

1821-30 

.796 

1867 

172 

164 

98.2 

1888 

99.2 

102. 1 

IOO 

1831-40 

.872 

1868 

167 

165 

96.4 

1889 

99.6 

102. 1 

IOO 

1841-50 

.852 

1869 

174 

163 

96.4 

1890 

100.0 

100.0 

IOO 

1851-60 

•975 

1870 

175 

J57 

95-5 

1891 

99-7 

101.4 

99.8 

1871 

178 

148 

95-5 

1892 

100.3 

99-5 

99.8 

1872 

174 

147 

95-5 

1893 

100.2 

102.0 

99.6 

1873 

175 

149 

95-5 

1894 

96.7 

97-4 

99.1 

1874 

170 

145 

95-5 

1895 

97-4 

95-5 

99.4 

1875 

161 

141 

93-6 

1896 

98-5 

93-3 

99.1 

1876 

156 

134 

93-6 

1897 

98.2 

94.0 

98.9 

1877 

146 

131 

93-6 

1898 

99.0 

96.4 

99.0 

. 

1878 

142 

126 

93-6 

1899 

100.2 

97.2 

98.5 

1 

1879 

140 

123 

93-6 

1900 

103. 1 

98.7 

98.0 

1880 

137 

125 

93-6 

1901 
1902 
1903 
1904 

104.8 
108.2 
in. 2 
in. 1 

102.7 
108.3 
107.7 
109. 1 

97-4 
96.6 

95-9 
95-2 

190S 

1 1 2.8 

109.8 

95-2 

1  Data  from  Report  of  Massachusetts  Bureau  of  Statistics  of  Labor  for  1885, 
P-  455- 

*  Data  from  Mitchell,  Gold,  Prices,  and  Wages  under  the  Greenback  Standard, 
pp.  242-244.  The  cost  of  living  here  is  based  upon  retail  prices  anc  'overs  rent  as 
well  as  food,  etc 


THE   PERSONAL   DISTRIBUTION  OF  WEALTH         549 

Regarding  the  second  fact,  we  may  say  that  certain  English 
investigations  show  that  more  than  one  fourth  of  the  population 
of  the  cities  of  London  and  York  are  below  the  poverty  line. 
To  be  sure,  it  is  not  easy  to  determine  definitely  how  pooi  a 
person  must  be  in  order  to  be  "  in  poverty,"  but  the  statement 
just  made  is  based  upon  standards  that  are  undeniably  con- 
servative. But  a  number  of  those  actually  in  poverty  have 
enough  income  to  purchase  the  minimum  physical  requirements 
if  they  knew  how  to  spend  their  money  wisely.  In  the  city  of 
York  9.91  per  cent  of  the  population  had  insufficient  earnings 
for  minimum  requirements  estimated  at  $5.25  per  week  for  a 
family  of  five.  This  minimum  is  very  low,  and  it  is  easily 
within  the  mark  to  say  that  at  least  a  fifth  of  the  population  of 
York  did  not  have  in  1899  a  sufficient  income  for  a  decent 
existence.  In  the  United  States  the  proportion  of  the  urban 
population  below  the  poverty  line  is  probably  somewhat  less, 
but  reliable  statistics  cannot  be  quoted. 

An  American  writer  has  estimated  that  ten  million  persons  in 
the  United  States  are  in  poverty,  not  all  in  distress,  but  "  much 
of  the  time  underfed,  poorly  clothed,  and  improperly  housed." 
The  estimate  is  based  on  statistics  of  unemployment,  returns  of 
boards  of  charity,  court  records  of  evictions,  and  pauper  burials. 
Whatever  the  actual  figures  may  be,  they  would  doubtless  be 
startling  in  comparison  with  statistics  of  our  industrial  progress. 

Causes  of  Poverty  and  Riches.  —  The  explanations  of  poverty 
and  riches  may  be  divided  into  two  classes :  (1)  those  that  em- 
phasize individual  responsibility,  and  (2)  those  that  emphasize 


•Based  upon  statistics  covering  21  industries  given  in  the  Aldrich  Report  on 
Wholesale  Prices,  Wages,  and  Transportation. 

*  Statistics  for  1881-1889  cover  25  city  occupations,  and  are  based  upon  data 
given  in  Bulletin  of  the  Bureau  of  Labor,  No.  18,  p.  669.  Statistics  for  1890-1905 
cover  349  occupations,  and  are  based  upon  data  given  in  Bulletin  of  the  Bureau  of 
Labor,  No.  65,  p.  20. 

8  Wholesale  prices  from  1881  to  1889,  based  upon  data  given  in  the  Aldrich  Report 
on  Wholesale  Wages,  Prices,  and  Transportation,  Part  i,  p.  99.  Retail  prices  of  food 
from  1890  to  1905,  from  the  Bulletin  last  cited. 

•  From  the  Aldrich  Report  and  Bulletin  cited  above.  After  1890,  statistics  are 
based  on  hours  of  labor  per  week. 


550  OUTLINES  OF  ECONOMICS 

social  responsibility.  According  to  the  first,  a  comfortable  for- 
tune is  the  reward  of  efficiency,  and  poverty  the  penalty  of  in- 
efficiency. To  find  fault  with  existing  wealth  distribution,  it 
is  alleged,  is  to  find  fault  with  nature  for  making  individual 
differences  in  ability  so  enormous.  That  there  are  idle  and 
worthless  persons  among  the  rich  is  not  to  be  denied,  but  they, 
it  is  said,  are  to  be  regarded  as  the  exceptions.  As  a  class, 
according  to  this  view,  the  rich  add  more  to  the  wealth  of  society 
than  they  consume,  and  they  do  not  in  reality  deduct  any- 
thing from  the  income  of  the  lower  classes. 

Those  who  emphasize  the  second  explanation,  on  the  other 
hand,  point  to  the  existence  of  all  sorts  of  special  privileges 
which  enable  the  few  to  levy  toll  on  the  production  of  the  nation. 
They  assert  that  the  fortunes  of  most  millionaires  originated 
under  the  shelter  of  some  monopolistic  enterprise.  As  to  the 
poor,  they  call  attention  to  the  fact  that  inefficiency  may  be 
the  result  of  poverty  as  well  as  the  cause  of  it.  Society  must, 
therefore,  take  active  measures  to  better  the  environment  of 
the  poor.  They  must  be  taught  to  live  wisely,  and  their  chil- 
dren must  be  given  a  fair  chance  in  life.  Children  who  do  not 
get  enough  to  eat  when  young  cannot  be  expected  to  take  care 
of  themselves  when  they  are  men  and  women. 

"The  prime  importance  of  monopoly  privileges  in  the  distribution  of 
wealth  is  shown  by  the  results  of  the  investigation  of  the  New  York  Tribune 
(1892)  in  its  efforts  to  ascertain  the  sources  of  the  fortunes  of  the  millionaires 
of  the  United  States.  That  investigation  was  undertaken  to  show  that  the 
system  of  protection  has  not  been  the  main  cause  for  monopolies  and  great 
fortunes.  The  investigation  amply  demonstrated  this  proposition.  Of 
the  4047  millionaires  reported,  only  11 25,  or  28  per  cent,  obtained  their 
fortunes  in  protected  industries.  The  following  partly  estimated  summaries 
are  based  on  the  Tribune  report.  They  show  that  about  78  per  cent  of  the 
fortunes  were  derived  from  permanent  monopoly  privileges  and  only  21.4 
per  cent  from  competitive  industries  unaided  by  natural  and  artificial  mo- 
nopolies. Yet  there  can  be  no  question  that  if  these  21.4  per  cent  were  fully 
analyzed,  it  would  appear  that  they  were  not  due  solely  to  personal  abilities 
unaided  by  these  permanent  monopoly  privileges.  They  were  mostly 
obtained  from  manufactures,  and  five  sixths  of  the  manufactures  of  the 
country  are  based  on  patents.  Besides,  fortunate  investments  in  real  estate, 
stocks,  etc.,  have  often  contributed  to  fortunes  where  they  do  not  appear 


THE   PERSONAL   DISTRIBUTION  OF  WEALTH         55 1 

prominently.  Furthermore,  if  the  size  of  the  fortunes  is  taken  into  account, 
it  will  be  found  that  perhaps  95  per  cent  of  the  total  values  represented 
by  these  millionaire  fortunes  is  due  to  those  investments  classed  as  land 
values  and  natural  monopolies  and  to  competitive  industries  aided  by  such 
monopolies."  x 

Those  who  take  this  second  view  do  not  deny  that  individual 
differences  in  ability  exist  and  are  a  cause  for  a  difference  in  for- 
tune. But  they  think  that  conditions  are  such  that  differences 
in  reward  are  quite  out  of  proportion  to  the  difference  in  ability. 
A  little  shrewdness  may  accumulate  a  fortune  just  as  the  touch 
of  a  child's  hand  may  start  a  bowlder  down  the  mountain  side. 

The  controversy  as  to  the  ultimate  responsibility  for  poverty 
cannot  be  settled  by  an  appeal  to  the  results  of  the  investigations 
that  have  been  made  as  to  the  immediate  causes  of  poverty. 
The  investigation  in  the  city  of  York,  before  referred  to,  gives 
the  following  as  the  immediate  causes  of  primary  poverty,  that 
is,  of  incomes  insufficient  to  provide  the  minimum  requirements 
for  physical  efficiency  even  if  wisely  spent : 

TABLE   V 

Immediate  Causes  of  "Primary"  Poverty2 


Per  Cent  of  Population 
in  Poverty 


Death  of  chief  wage  earner 

Illness  or  old  age  of  chief  wage  earner 
Chief  wage  earner  out  of  work   .... 

Irregularity  of  work 

Size  of  family,  i.e.  more  than  four  children 
In  regular  work  but  at  low  wages  .     .     . 


15-63 

5-" 

2.31 

2.83 

22.16 

51.96 


Is  Greater  Diffusion  Possible  ?  —  Most  people  agree  that  a 
greater  equality  of  possessions  would  be  desirable  if  it  could  be 
brought  about  without  any  confiscation  of  the  real  earnings  of 
the  more  efficient  members  of  society.     The  idea  of  a  leisure 

1  J.  R.  Commons,  The  Distribution  of  Wealth,  p.  252. 

2  B.  S.  Rowntree,  Poverty,  p.  120. 


552  OUTLINES  OF  ECONOMICS 

class  whose  mission  it  is  to  further  culture  without  substantial 
contributions  to  the  production  of  what  it  consumes,  does  not 
find  much  favor  in  this  democratic  age.  The  disadvantages  of 
wide  extremes  in  wealth  have  been  so  often  pointed  out  by 
social  philosophers  that  they  need  not  be  emphasized  here. 
But  those  who  believe  that  the  competitive  system  roughly 
apportions  rewards  according  to  individual  production  will  say 
that  nothing  can  be  done  directly  to  diffuse  wealth.  That 
each  individual  should  bear  the  consequences  of  his  own  con- 
duct, they  think,  is  necessary  as  a  discipline  for  the  race.  "  Give 
the  children  of  the  shiftless,  by  thoughtless  charity  or  various 
systems  of  poor  relief,  the  right  to  eat  the  substance  of  the  effi- 
cient and  the  prudent,  and  you  will  soon  lose  both  the  capital 
and  the  morality  under  which  that  capital  has  been  created,"  l 
says  one  able  writer. 

Those,  on  the  other  hand,  who  think  that  something  can  and 
should  be  done,  question  the  possibility  of  discovering  the  real 
contributions  of  individual  workers  under  modern  complex  in- 
dustrial conditions  with  any  degree  of  exactness,  and  think  there 
is  little  danger  of  discouraging  industry  and  thrift.  If  the 
highest  incomes  were  $100,000  per  year,  men  would  struggle  just 
as  hard  as  they  do  now  to  get  into  the  highest  class. 

If  we  take  the  view  that  something  can  be  done  to  lessen  the 
extreme  inequality  in  wealth  distribution  that  exists  at  the 
present  time,  it  is  necessary  to  formulate  some  program  of 
social  reform.  In  framing  such  a  program  it  must  be  re- 
membered, on  the  one  hand,  that  the  right  of  private  property 
is  not  an  absolute  right.  No  one  has  a  vested  interest  in  that 
institution,  and  we  are  at  liberty  to  make  such  modification  in 
the  institution  as  will  contribute  to  the  social  welfare.  For  the 
present  the  measures  here  advocated  are  not  in  the  slightest 
danger  of  being  carried  so  far  as  to  discourage  that  wealth- 
getting  ambition  which  is  considered  by  many  to  be  essential 
to  progress.  On  the  other  hand,  there  is  danger  of  injuring  by 
wrong  methods  the  very  persons  whom  it  is  desirable  to  elevate. 
Indiscriminate  charity  may  convert  poverty  to  pauperism. 

1  A.  T.  Hadley,  Economics,  p.  49. 


THE  PERSONAL  DISTRIBUTION  OF  WEALTH         553 

"This  distinction  between  the  poor  and  the  paupers  may  be  seen  every- 
where. There  are,  in  all  large  cities  in  America  and  abroad,  streets  and 
courts  and  alleys  where  a  class  of  people  live  who  have  lost  all  self-respect  and 
ambition,  and  who  rarely  if  ever  work,  who  are  aimless  and  drifting,  who  like 
drink  and  who  have  no  thought  for  their  children,  and  who  live  aimless  and 
contentedly  on  rubbish  and  alms.  ...  In  our  American  cities, Negroes, 
Whites,  Chinese,  Mexicans,  Half-breeds,  Americans,  Irish,  and  others  are 
indiscriminately  housed  together  in  the  same  tenements  and  often  in  the 
same  rooms.  The  blind,  the  crippled,  the  consumptive,  the  aged,  —  the 
ragged  ends  of  life;  the  babies,  the  children,  the  half-starved,  underclad 
beginnings  in  life,  all  huddled  together,  waiting,  drifting.  This  is  pauper- 
ism. There  is  no  mental  agony  here;  they  do  not  work  sore;  there  is  no 
dread ;   they  live  miserably,  but  they  do  not  care. 

"In  these  same  cities,  and  indeed  everywhere,  there  are  great  districts  of 
people  who  are  up  at  dawn,  who  wash  and  dress,  and  eat  breakfast,  kiss 
wives  and  children,  and  hurry  away  to  work  or  to  seek  work.  The  world 
rests  upon  their  shoulders ;  it  moves  by  their  muscle ;  everything  would  stop 
if  for  any  reason  they  should  decide  not  to  go  into  the  fields  and  factories  and 
mines.  But  the  world  is  so  organized  that  they  gain  enough  to  live  upon 
only  when  they  work ;  should  they  cease,  they  are  in  destitution  and  hunger. 
The  more  fortunate  of  the  laborers  are  but  a  few  weeks  from  actual  distress 
when  the  machines  are  stopped.  Upon  the  unskilled  masses  want  is  con- 
stantly pressing.  As  soon  as  employment  ceases,  suffering  stares  them  in 
the  face.  They  are  the  actual  producers  of  wealth,  but  they  have  no  home 
nor  any  bit  of  soil  which  they  can  call  their  own.  They  are  the  millions  who 
possess  no  tools~and  can  work  only  by  permission  of  another.  In  the  main 
they  live  miserably,  they  know  not  why.  They  work  sore,  and  yet  gain  noth- 
ing. They  know  the  meaning  of  hunger  and  the  fear  of  want.  They  love 
their  wives  and  children.  They  try  to  retain  their  self-respect.  They  have 
some  ambition.  They  give  to  neighbors  in  need,  yet  they  are  themselves  the 
actual  children  of  poverty."  l 

We  shall  not  discuss  here  the  methods  of  alleviating  the  suf- 
fering that  comes  from  poverty.  The  best  methods  of  charit- 
able relief  are  necessary  as  palliatives,  but  they  cannot  cure  the 
evils  of  poverty.  Two  classes  of  reform  measures  should  be 
distinguished :  (1)  those  that  aim  to  alter  the  methods  of  wealth 
acquisition  in  the  future,  and  (2)  those  that  aim  to  diffuse  the 
excessive  accumulations  of  the  past. 

Modifying  the  Methods  of  Wealth  Acquisition.  —  These 
measures  again  fall  into  two  classes :  (a)  prevention  of  improper 

1  R.  Hunter,  Poverty,  pp.  3-5. 


554  OUTLINES  OF  ECONOMICS 

methods  of  wealth  accumulation ;  (b)  eliminating  or  strengthen- 
ing the  inefficient  members  of  society.  Under  the  first  of  these 
falls  the  problem  of  reducing  to  lower  terms  such  incomes  as 
are  individually  unearned.  There  must  be  such  control  of 
monopolistic  privileges  as  to  keep  them  from  being  the  means 
of  exploiting  the  public.  Fraud  and  favoritism  must  be  elim- 
inated so  that  income  shall  not  be  wholly  out  of  proportion 
to  service  or  needs. 

The  second  class  includes  a  large  variety  of  methods,  (i)  It 
is  possible  to  do  something  to  prevent  defective  human  beings 
from  being  born.  There  is  a  growing  sentiment  in  favor  of 
preventing  the  marriage  of  persons  who  are  not  fit  for  marriage. 
No  individual  would  be  deprived  of  any  important  right  if  a 
medical  certificate  of  good  health  were  made  a  condition  pre- 
cedent to  the  granting  of  a  marriage  license,  although  here 
education  may  prove  the  more  effective  remedy.  (2)  Education 
should  be  made  compulsory,  with  the  endeavor  of  making  the 
rising  generation  not  only  efficient  producers,  but  also  wise 
spenders  of  what  they  receive.  (3)  It  is  possible  to  provide 
against  the  misfortunes  of  life  by  insurance  of  various  kinds. 
If  men  will  not  voluntarily  make  provision  for  themselves  and 
for  those  dependent  upon  them  in  cases  of  sickness,  accident, 
old  age,  and  premature  death,  they  should  be  helped  to  do  so 
indirectly  by  some  comprehensive  system  of  workingmen's 
insurance  and  old  age  pensions.  (4)  The  solution  of  the  prob- 
lem of  unemployment  depends  in  part  upon  indirect  measures, 
such  as  monetary  and  banking  reform,  which  steady  the  prog- 
ress of  industry,  although  more  efficient  labor  exchanges  and 
unemployment  insurance  are  direct  measures  which  are  of  some 
help.  If  business  men  and  political  leaders  ever  become  as 
much  interested  in  the  problems  of  unemployment  as  in  tariff 
reform,  we  may  expect  that  productive  use  will  be  found  for 
the  unemployed  so  far  as  they  are  employable,  and  if  this  proves 
impracticable,  we  shall  recognize  that  if  society  cannot  offer 
a  willing  and  able  man  an  opportunity  to  work,  it  must  give 
him  a  vacation  with  pay.  (5)  Opportunities  for  saving  should 
be  multiplied.     The  establishment  of  our  postal-savings  system 


THE   PERSONAL  DISTRIBUTION  OF  WEALTH         555 

is  a  small  step  in  this  direction.  (6)  The  health  and  vigor  of 
the  people  should  be  improved  by  more  efficient  use  of  "  pre- 
ventive medicine  "  and  public  hygiene  in  all  its  various  phases, 
and  by  improvement  in  the  conditions  of  work. 

The  Diffusion  of  Wealth.  —  To  some  extent  large  fortunes  dis- 
appear without  governmental  interference,  but  it  takes  com- 
paratively slight  ability  to  maintain  an  inherited  estate.  It 
does  not  seem  practicable  or  desirable  to  limit  directly  the  total 
amount  of  wealth  which  a  man  may  own,  but  there  is  no  reason 
why  the  government  should  refrain  from  consciously  encourag- 
ing the  diffusion  of  wealth.  The  regulation  and  taxation  of 
inheritances  seems  to  be  the  proper  remedy  in  this  connection, 
even  if  its  action  is  somewhat  slow. 

QUESTIONS  AND-  EXERCISES 

1.  Can  anything  be  said  in  favor  of  a  leisure  class? 

2.  Would  Mr.  Carnegie's  plan  of  levying  an  inheritance  tax  of  50  per  cent 
destroy  the  incentive  to  work? 

3.  Explain  the  various  systems  of  poor  relief. 

4.  Describe  the  work  of  some  public  employment  office. 

5.  Describe  the  growth  of  postal  savings. 

6.  What  were  the  causes  of  the  development  of  the  fortune  of  John  Jacob 
Astor  ? 

7.  Discuss  the  following  statement:  "We  have,  then,  little  reason  for 
expecting  that  the  prevailing  insecurity  in  the  lot  of  the  modern  workman 
will  ever  be  removed  by  the  development  of  individual  thrift."  —  A.  S.  John- 
son, Political  Scietice  Quarterly,  Vol.  xxii,  p.  244. 

REFERENCES 

Adams,  T.  S..  and  Sumner,  H.  L.     Labor  Problems,  Chap.  v. 

Brooks,  J.  G.     The  Social  Unrest,  Chap.  vii. 

Booth.     Life  and  Labour  of  the  People  in  London,  final  volume. 

Commons,  J.  R.     Distribution  of  Wealth,  pp.  252  seq. 

Devine,  E.  T.     Principles  of  Relief. 

Ely,  R.  T.     Property  and  Contract,  Vol.  i,  Chap.  xiii. 

Falkner,  R.  P.,  "Income  Tax  Statistics,"  Quarterly  Publications  of  the 

American  Statistical  Association,  Vol.  xiv,  p.  521. 
Hadley,  A.  T.     Economics,  pp.  39-63,  330-335. 
Hollander,  J.  H.     The  Abolition  of  Poverty,  Chaps,  ii,  viii. 
Hunter,  Robert.    Poverty. 


556  OUTLINES   OF   ECONOMICS 

Hobson,  J.  A.     The  Social  Problem,  Chap,  iv ;  Problems  of  Poverty,  Chap.  ix. 

Henderson,  C.  R.    Modern  Methods  of  Charity. 

Johnson,  A.  S.     "Influences  affecting  the  Development  of  Thrift,"  Political 

Science  Quarterly,  Vol.  xxii. 
King,  W.  I.     The  Wealth  a?id  Income  of  the  People  of  the  United  States. 
Rowntree.     Poverty:  A  Study  in  Town  Life. 
Streighthoff,  F.  H.     "The  Distribution  of  Incomes,"  Columbia  University 

Studies  in  History,  Economics,  and  Public  Law,  Vol.  iii,  No.  2. 
Taussig,  F.  W.     Principles  of  Economics,  Vol.  ii,  Chap.  liv. 
Warner,  A.  G.     American  Charities. 
Watkins,  G.  P.     "The  Growth  of  Large  Fortunes,"  Publications  of  the 

American  Economic  Association,  Third  Series,  Vol.  vii,  No.  2. 
Youngman,  Anna.    Economic  Causes  of  Great  Fortums. 


PART   IV 

SELECTED   ECONOMIC   PROBLEMS 

CHAPTER  XXVII 
TRANSPORTATION   ECONOMICS 

Transportation  Economics  Denned.  —  Transportation  may 
be  studied  from  various  points  of  view.  It  presents  its  peculiar 
problems  to  the  engineer,  to  the  lawyer,  to  the  financier,  to  the 
accountant,  to  the  operating  official,  and  finally  to  the  economist. 
The  economist  studies  the  relations  of  transportation  to  other 
industries  and  to  the  public  welfare.  Leaving  to  the  engineer 
the  building  of  bridges,  to  the  accountant  the  recording  of  the 
condition  of  the  business,  and  to  the  general  manager  the 
securing  of  efficient  operation,  we  turn  our  attention  primarily 
to  the  principles  that  govern  the  determination  of  rates  and 
fares,  although  there  are  many  other  problems  to  be  considered 
in  transportation  economics,  some  of  them  peculiar  to  this 
field  and  some  but  special  illustrations  of  principles  underlying 
all  industry.  We  make  use  of  the  technical  knowledge  of  the 
engineer  and  of  the  other  specialists  that  have  been  mentioned, 
and  yet  our  point  of  view  is  distinct. 

Scope  of  the  Term  Transportation.  —  A  complete  treatment 
of  the  subject  of  this  chapter  would  involve  a  consideration  of 
steam  railways,  interurban  and  city  railways,  the  common 
roads,  water  transportation,  as  well  as  the  post  office,  the  tele- 
graph and  the  telephone.  Aerial  transportation  may  bring  new 
economic  problems  in  the  future.  But  it  will  be  necessary  in 
this  chapter  to  confine  the  discussion  to  some  of  the  leading 
principles   in   the   economics   of   railroad   transportation.     As 

557 


558  OUTLINES  OF  ECONOMICS 

explained  in  Chapter  VI,  the  early  turnpike  era  was  followed  by 
one  of  canal  building,  and  this  in  turn  by  the  railroad  era.  We 
are  now  realizing  that  we  must  enter  upon  a  new  era  of  road 
building  and  of  the  improvement  of  waterways.  Canal  and 
river  improvement,  however,  should  be  urged,  not  on  the  general 
ground  that  water  transportation  is  cheap,  but  only  in  specific 
instances  where  it  can  be  shown  to  be  as  advantageous  as  rail 
transportation  when  all  of  the  elements  of  expense  are  taken  into 
consideration.  It  is  a  matter  of  debate,  for  example,  wrhether 
the  recent  construction  of  the  New  York  barge  canal  was 
economically  justified.  The  improvement  of  our  common 
roads  is  now  being  vigorously  forwarded  by  state  and  local 
activity.  In  1916  the  federal  government  made  an  appropria- 
tion to  aid  the  states  in  carrying  on  this  work. 

Nature  of  the  Railway  Industry.  —  Hardly  anything  can  be 
produced  without  the  participation  of  some  transport  agency. 
Modern  industrial  civilization  would  be  impossible  without  an 
efficient  system  of  commercial  intercourse.  The  dependence  is 
mutual,  for  present  methods  of  transportation  clearly  would  be 
uneconomical  without  a  large  traffic.  The  influence  of  cheap- 
transportation  is  especially  important  in  the  fact  that  it  promotes 
an  extensive  division  of  labor  by  widening  the  market.  It  per- 
mits each  region  to  devote  itself  to  that  line  of  production  for 
which  it  is  best  adapted. 

The  number  of  persons  employed  by  railways  in  the  United 
States  in  1910  was  about  1.7  millions,  which  was  4.45  per  cent 
of  the  number  of  gainful  workers  reported  by  the  census  of  that 
year.  This  percentage  probably  understates  the  relative  impor- 
tance of  transportation  as  compared  with  other  economic  ac- 
tivities, because  the  capital  per  employee  is  larger  in  the  railway 
industry  than  in  other  lines  of  work.  An  attempt  has  sometimes 
been  made  to  minimize  the  importance  of  the  question  of  rail- 
road rates  by  comparing  the  transportation  charge  on  such  an 
article  as  a  pair  of  shoes  with  the  cost  of  the  shoes  and  showing 
that  it  is  too  small  appreciably  to  affect  the  retail  price.  This 
overlooks  the  fact  that  freight  charges  enter  into  the  cost  of  the 
materials  and  of  the  machinery  required  to  produce  the  shoes. 


TRANSPORTATION   ECONOMICS  559 

The  freight  charge  constitutes  a  large  percentage  of  the  cost  of 
such  an  article  as  coal.  But,  on  the  other  hand,  the  importance 
of  changes  in  freight  rates  is  sometimes  overemphasized  by  com- 
paring the  total  annual  freight  revenue  per  family  with  the 
estimated  income  of  the  average  family.  Thus  in  the  year 
ending  June  30,  1910,  the  freight  revenue  of  railways  in  the 
L'nited  States  was  $1,925,553,036,  and  the  number  of  families 
as  reported  by  the  census  of  1910  was  20,255,555,  making 
an  average  of  ninety-five  dollars  per  family.  It  should  be 
obvious  that  this  figure  cannot  be  compared  with  the  amount 
which  the  average  family  spends  for  food,  clothing,  and  other 
items  of  final  consumption.  If  the  comparison  is  made  at 
all,  it  must  be  with  the  total  annual  production  of  the  nation 
per  family,  for  freight  charges  enter  into  the  cost  of  such 
items  as  the  factories,  war-ships,  and  railway  bridges  con- 
structed each  year  as  well  as  of  the  articles  produced  for  final 
consumption. 

Railways  differ  from  manufacturing  industries  in  that  they 
produce  place  utility  and  not  form  utility,  and  in  the  further 
fact  that  it  is  customary  for  manufacturers  to  own  the  materials 
which  they  change  in  form  while  railways  as  a  rule  do  not  own 
the  materials  which  they  transport.  In  other  words,  railways 
sell  services  simply,  while  manufacturers  sell  articles  in  which 
they  have  embodied  certain  services.  The  freight  charges  paid 
by  the  shipper  may  be  compared  with  the  toll  which  the  farmer 
used  to  pay  for  having  his  corn  ground  at  the  mill.  The  fact 
that  railways  do  not  buy  and  sell  the  commodities  to  which  they 
add  utility  as  manufacturers  do,  makes  the  amount  of  their 
yearly  income  and  outgo  much  smaller  in  comparison  with  the 
amount  of  capital  employed  than  is  the  case  with  manufacturers. 
Roughly  speaking,  it  takes  railways  five  years  to  "  turn  over  " 
their  capital,  the  total  operating  revenues  of  the  railways  in  the 
United  States  being  about  three  billions  of  dollars  a  year,  while 
their  capitalization  is  about  fifteen  billions  (excluding  intercor- 
porate duplications).  For  the  year  1909,  the  Bureau  of  the 
Census  reports  manufacturing  establishments  as  having  a  capital 
of  18.4  billions  of  dollars  and  an  annual  value  of  products  of 


560  OUTLINES  OF   ECONOMICS 

20.7  billions.  The  value  of  products  less  cost  of  materials  pur> 
chased,  that  is,  the  value  added  by  the  manufacturing  process, 
was  8.5  billions.  While  no  accurate  comparisons  are  possible 
from  these  data,  they  warrant  the  conclusion  that  capital  is 
relatively  much  more  important  as  a  factor  of  production  in  the 
railway  industry  than  in  manufacturing  enterprises  taken  as  a 
whole.  The  fact  that  railway  services  are  rendered  in  con- 
nection with  a  large  fixed  capital  explains  much  in  our  railway 
history,  especially  with  respect  to  matters  relating  to  competi- 
tion, monopoly,  and  rate  making. 

Railway  Competition.  —  The  early  roads  were  short,  independ- 
ent lines,  largely  for  local  traffic  or  to  serve  as  feeders  to  canals. 
The  first  movement  toward  the  efficiency  of  the  present  system 
was  the  welding  together  of  separate  links  into  through  lines. 
The  New  York  Central,  for  example,  was  formed  in  1853  out  of 
ten  or  eleven  previously  independent  lines  between  Albany  and 
Buffalo.  The  development  of  parallel  through  lines  introduced 
an  era  of  sharp  competition.  In  the  seventies  the  lines  connect- 
ing Chicago  and  the  Atlantic  seaboard  engaged  in  a  series  of  rate 
wars.  The  experience  of  this  decade  showed  clearly  the  tempo- 
rary and  unstable  character  of  competition  among  parallel  lines. 
The  rule  seemed  to  be  that  a  railway  war  must  be  followed  by  a 
rate  agreement  of  some  sort,  so  that  instead  of  the  maintenance 
of  a  supposedly  fair  level  of  rates  by  the  steady  pressure  of  com- 
petition, we  find  there  was  an  alternation  of  high  and  low  rates. 
The  inevitable  annihilation  of  direct  competition  in  rates  be- 
tween railways  is  clearly  portrayed  in  a  congressional  report  in 
1874,  where  the  following  prediction  was  made :  "  But  when  the 
natural  tendencies  of  corporate  power  have  wrought  out  their  in- 
evitable conclusions,  the  magnitude  of  our  combinations  will 
probably  be  in  proportion  to  the  extent  of  the  field  in  which  they 
operate."  But  so  strongly  was  it  felt  at  that  time  that  competi- 
tion is  the  life  of  trade,  that  the  committee  which  made  this 
report  recommended  that  the  government  build  a  line  of  its 
own,  merely  to  maintain  competition  with  the  private  roads,  for 
it  was  thought  that  the  government  could  resist  the  temptation 
to  enter  into  a  combination. 


TRANSPORTATION   ECONOMICS  561 

The  history  of  Belgium  affords  an  instructive  illustration  of  the  effect  oi 
a  mixed  system  of  public  and  private  ownership.  Belgium  began  in  1837 
with  a  carefully  planned  system  of  public  railways.  Ten  years  later  it 
was  decided  to  grant  charters  to  private  companies.  A  large  number  of 
private  roads  was  organized,  some  with  the  purpose  of  competing  with  the 
state  system.  It  was  thought  that  competition  between  the  state  and  private 
roads  would  be  beneficial.  The  Massachusetts  Railroad  Commission,  in  its 
report  of  187 1,  recommended  a  trial  of  this  plan  in  Massachusetts.  But  ir 
Belgium  the  private  lines  were  soon  merged  into  four  systems,  which  com- 
peted so  vigorously  with  the  state  roads  that  the  government  adopted  the 
policy  of  purchasing  them. 

Pooling  and  Consolidation. —  As  a  result  of  the  intense  struggle 
for  business  among  the  roads,  there  was  a  widespread  resort  to 
the  practice  of  pooling,  that  is,  a  division  of  the  earnings  or  ton- 
nage of  the  aggregate  business.  This  form  of  combination, 
however,  was  at  least  nominally  abandoned  after  it  was  declared 
illegal  by  the  Interstate  Commerce  Act  of  1887,  but  organiza- 
tions for  the  purpose  of  making  rates  continued  to  exist.  In 
1897  these  were  also  declared  illegal  by  the  Supreme  Court  of  the 
United  States  on  the  ground  that  they  were  in  violation  of  the 
Anti-trust  Act  of  1890.1  The  decision,  however,  did  not  clearly 
prohibit  the  enlargement  of  the  various  systems  by  the  purchase 
and  lease  of  other  lines,  or  by  securing  indirect  control  by  the 
purchase  of  the  majority  of  their  stock.  But  in  1904  the  Su- 
preme Court  again  applied  the  Anti-trust  Act  of  1890  in  a  case 
against  the  Northern  Securities  Company,  a  corporation  formed, 
not  for  the  purpose  of  directly  engaging  in  the  railway  business, 
but  for  the  purpose  of  holding  the  capital  stock  of  the  Great 
Northern,  Northern  Pacific,  and  Burlington  systems,  two  of 
which  were  competing  systems.  In  191 2  it  was  decided  that  for 
the  Union  Pacific  Railroad  Company  to  hold  indirectly  46  per 
cent  of  the  stock  of  the  Southern  Pacific  Company  was  illegal, 
although  only  a  small  percentage  of  the  total  traffic  of  these 
roads  could  be  regarded  as  competitive.  The  Northern  Securi- 
ties decision  did  not  prevent  the  systems  involved  from  con- 
tinuing to  be  controlled  by  the  same  financial  interests,  but  the 
Union  Pacific  case  has  apparently  resulted  in  severing  the  finan- 
1  See  p.  237,  above. 


562  OUTLINES  OF   ECONOMICS 

cial  control  of  the  Union  Pacific  from  that  of  the  Southern 
Pacific. 

The  present  organization  of  any  one  of  our  large  systems,  like 
a  geological  record,  reveals  the  nature  of  the  changes  that  have 
been  going  on.  The  consolidated  company  controls  a  number  of 
large  lines,  perhaps  by  stock  ownership,  and  each  one  of  these  is 
made  up  of  a  number  of  subsidiary  roads  united  as  a  result  of 
purchase,  partial  stock  ownership,  or  lease. 

Thus  the  Baltimore  and  Ohio  in  191 2  operated  4455  miles  of 
line,  of  which  it  owned  545  miles,  while  3897  miles  were  con- 
trolled through  partial  or  complete  stock  ownership,  the  re- 
mainder being  operated  under  lease  or  trackage  rights.  It  also 
controlled  the  Cincinnati,  Hamilton,  and  Dayton,  an  independent 
operating  company.  There  are  numerous  illustrations  of  the 
control  of  one  large  operating  company  by  one  or  more  other 
operating  companies.  Thus  the  Northern  Pacific  and  Great 
Northern  Companies  jointly  control  the  Burlington.  Again, 
several  operating  companies  may  be  controlled  by  a  holding  com- 
pany which  does  not  itself  operate  any  mileage.  This  is  the  case 
with  the  Louisville  and  Nashville  and  the  Atlantic  Coast  Line 
Railroads,  both  of  which  are  subsidiary  to  the  Atlantic  Coast 
Line  Company.  Again,  two  or  more  railroads,  apparently  quite 
independent  of  each  other  in  the  matter  of  stock  ownership,  may 
nevertheless  be  dominated  by  the  same  financial  interests.  Thus 
the  Morgan  interests  control  the  Erie  and  the  Southern  as  well 
as  other  railroads.  It  is  safe  to  say  that  ten  groups  of  capital- 
ists control  over  three  fourths  of  the  railway  mileage  of  the 
United  States. 

In  spite  of  the  progress  of  consolidation,  competition  has  not 
entirely  disappeared.  Even  where  there  is  no  active  cutting 
of  rates  by  parallel  lines,  there  may  be  rivalry  in  service;  but 
this  form  of  competition  has  also  proven  to  be  unstable  and 
unsatisfactory,  as  is  seen  in  problems  arising  in  connection  with 
terminal  freight  services.  Again,  alternative  routes  may  lead 
to  competition  among  railways  that  are  not  parallel.  Thus 
the  roads  serving  the  north  Atlantic  ports  compete  in  the 
carriage  of  grain  with  those  extending  to  Galveston  and  New 


TRANSPORTATION  ECONOMICS  503 

Orleans.  The  influence  of  water  competition  on  railway  rates 
has  been  recognized  by  the  Interstate  Commerce  Commission  in 
the  adjustment  of  transcontinental  rates  and  in  the  numerous 
exceptions  it  permits  in  the  southern  states  to  the  rule  that  the 
charge  for  the  shorter  haul  shall  not  exceed  that  for  the  longer. 
The  activities  of  the  traffic  departments  of  railways  indicates 
the  existence  of  competition  for  business  at  many  points. 
The  Panama  Canal  will  be  a  factor  in  railway  competition. 

Much  has  recently  been  said  about  the  influence  of  market 
competition  as  a  force  affecting  rates,  even  when  the  roads  have 
been  consolidated.  To  illustrate,  the  farmers  and  railways  of 
North  Dakota  are  joint  producers  of  wheat,  and  they  are  both 
desirous  that  it  shall  be  sold  in  competition  with  other  wheat  in 
the  London  market.  It  would  be  ruinous  to  the  roads  to  make 
such  high  rates  that  the  farmers  could  not  afford  to  sell  their 
grain.  The  railways  cannot  be  prosperous  if  the  farmers,  mer- 
chants, and  manufacturers  along  their  lines  are  not  prosperous. 
This  partnership,  however,  has  its  limits,  for  a  rate  which  would 
enable  the  producer  to  continue  in  business  might  still  be  un- 
reasonably high. 

The  Movement  of  Rates.  —  The  average  revenue  per  ton  mile 
of  traffic  in  the  United  States  fell  from  1.001  cents  in  1888  to 
.729  cents  in  1900,  rising  to  .780  in  1904,  and  falling  again  to 
.729  in  1913.  Average  ton-mile  receipts,  however,  are  not  an 
accurate  index  of  changes  in  rates,  for  this  average  is  affected 
by  the  changes  in  the  nature  of  the  traffic  as  well  as  by  changes 
in  rates  charged.  The  average  ton-mile  revenue  is  really  a 
weighted  index  number  with  changing  weights  at  different  peri- 
ods. If  the  proportion  of  low-grade  freight  increases,  or  if  the 
length  of  haul  increases,  there  will  be  a  fall  in  ton-mile  receipts 
without  any  change  in  rates.  But  if  we  also  take  into  consider- 
ation rates  on  specific  commodities,  such  as  wheat,  or  stoves, 
between  specific  points,  no  doubt  remains  but  that  a  large  de- 
crease in  freight  rates  took  place  up  to  the  year  1900.  Since 
that  time  there  have  been  many  increases  in  published  rates, 
but  also  many  decreases  have  been  made  by  order  of  various 
regulating  bodies.     It  may  be  that  the  net  effect  of  these  changes 


564  OUTLINES  OF  ECONOMICS 

is  fairly  well  represented  by  the  ton-mile  revenue,  which  has 
shown  little  change  since  1900,  although  there  has  been  some 
increase  in  the  proportion  of  low-grade  tonnage  and  in  the  aver- 
age length  of  haul  between  1900  and  1913,  which  would  seem 
to  indicate  some  increase  in  rates  since  1900. 

In  1910  the  railway  companies,  both  in  the  East  and  in  the 
West,  asked  the  Interstate  Commerce  Commission  to  sanction 
a  general  increase  in  freight  rates.  This  it  refused  to  do.  In 
1914,  a  renewed  request  for  permission  to  increase  rates  on  the 
part  of  Eastern  carriers  was  at  first  denied  but  later  granted. 
In  191 5  an  advance  in  rates  on  a  long  list  of  commodities  was 
proposed  by  carriers  in  the  Middle  West.  The  commission 
permitted  certain  of  the  advances  proposed  and  denied  others. 
Railway  representatives  assert  that  rates  should  increase  when 
prices  generally  are  increasing,  but  they  have  failed  to  demon- 
strate any  general  increase  in  their  own  "cost  of  living"  except 
in  the  higher  rates  of  wages  paid  and  the  higher  rates  of  interest 
recently  prevailing.  In  the  years  following  1908,  passenger 
rates  were  radically  reduced  in  many  states  by  two-cent  fare 
laws.  The  average  revenue  per  passenger  per  mile  had  shown 
little  change  prior  to  that  time  since  the  early  nineties,  when 
it  was  somewhat  higher.  Recently  Eastern  railways  have 
also  made  general  increases  in  passenger  rates.  A  joint  com- 
mittee of  Congress  recommended  in  19 14  that  the  payments 
to  railroads  for  carrying  the  mails  be  increased. 

These  general  changes  or  proposed  changes  in  rates  and  fares 
give  renewed  interest  to  the  question  of  how  a  reasonable  rate 
may  be  determined.1 

1  It  is  left  as  an  exercise  for  the  student  to  draw  charts  of  the  movement  of  rev- 
enues per  ton  per  mile  and  per  passenger  per  mile  from  the  Statistics  of  Railways 
published  by  the  Interstate  Commerce  Commission,  and  to  compare  at  different 
dates  the  average  length  of  haul  and  the  proportions  of  various  kinds  of  commodities 
carried.  But  it  must  be  remembered  that  the  average  revenue  per  ton  per  mile 
is  a  single  figure  representing  the  result  of  applying  an  almost  infinite  variety  of 
specific  rates  under  varying  traffic  conditions.  This  is  at  once  the  advantage  and 
defect  of  an  average.  To  emphasize  this  point  the  average  receipts  per  ton  per 
mile  are  given  in  the  following  table  for  eight  selected  commodities  by  geographical 
districts.  The  average  length  of  haul  as  given  in  this  table  is  obtained  by  dividing 
the  tons  per  mile  by  the  number  of  tons  carried,  as  reported  by  each  railroad,  in- 


TRANSPORTATION   ECONOMICS 


565 


The  Level  of  Rates.  —  If,  owing  to  the  monopolistic  nature  of 
the  railway  business,  the  determination  of  rates  can  no  longer  be 
left  to  the  automatic  working  of  competitive  forces,  they  must 
be  consciously  determined  according  to  fundamental  principles. 
Competition  was  supposed  to  do  justice  by  limiting  the  aggregate 
earnings  of  an  establishment  approximately  to  the  expenses  of 

eluding  both  the  tons  originating  on  the  line  of  the  carrier  and  the  tons  received 
from  connecting  carriers.  The  average  haul,  therefore,  is  the  average  haul  on  one 
railroad  and  not  the  average  haul  for  the  railroads  regarded  as  one  system. 
For  all  commodities  taken  together  in  19.13  the  average  haul  of  a  ton  on  one  rail- 
road was  147  miles  as  against  260  miles  for  all  the  railroads  regarded  as  a  system. 
This  last  figure  is  obtained  by  dividing  the  ton-miles  by  the  number  of  tons  re- 
ported as  originating  on  carriers'  lines,  excluding  the  tonnage  received  from  con- 
necting carriers.  The  same  correction  cannot  be  made  for  the  individual  com- 
modities. The  following  table,  it  may  also  be  noted,  does  not  cover  all  of 
the  mileage  of  the  country,  as  many  railroads  do  not  compile  traffic  statistics  in 
this  form. 

Average  Receipts  per  Ton  per  Mile  and  Average  Length  of  Haul  for 
Selected  Commodities  in  Carload  Lots  for  Year  Ending  June  30,  1913, 
Covering  151,941  Miles  of  Road 

(From  Statistics  of  Railways  in  the  United  States,  1913,  p.  44.) 


District  and  Item 
Covered 

< 

0 

z 
0 

E 

0 
u 

H 

2  B 

£  < 

M 

0 

< 

P  0 
1° 

6 

0 

§  < 

A 

OS 
hi 

n 

g  . 

►J 

Eastern  District 

Receipts  per  ton-mile 

—  cents 
Length  of  haul  —  miles 

0.375 
262 

0.851 
158 

0.538 
252 

O.842 
228 

0.893 
327 

O.S7I 
170 

O.417 
126 

0.623 
148 

Southern  District 

Receipts  per  ton-mile 

—  cents 
Length  of  haul  —  miles 

0.620 
250 

0.938 
193 

1.927 
179 

1-723 
138 

1043 
255 

0-555 
119 

O.4O3 
ISO 

0.734 
161 

Western  District 

Receipts  per  ton-mile 
—  cents 
Length  of  haul  —  miles 

0.740 
236 

i-i55 
162 

1.792 
230 

1-397 
209 

1. 106 

327 

0.630 
173 

O.676 
117 

0.713 

200 

Total  — A 11  Districts 

Receipts  per  ton-mile 

—  cents 
Length  of  haul —  miles 

0.581 
248 

1.005 
166 

1.693 
214 

I.258 
209 

0965 
323 

0.578 

170 

O.447 
135 

0.701 
176 

566  OUTLINES  OF   ECONOMICS 

doing  the  business,  and  it  seems  most  natural  that  we  should  ap- 
ply the  same  standard  in  our  railway  rate  making.  There  can  be 
no  doubt  but  that  expense  is  a  safe  guide  so  far  as  it  can  be  ac- 
curately determined.  It  needs  but  a  slight  analysis  of  railway 
expenditure,  however,  to  reveal  the  difficulty  of  using  expense  as 
a  criterion  of  a  fair  rate.  In  1 913  the  railways  reported  to  the  In- 
terstate Commerce  Commission  operating  revenues  and  other  in- 
come amounting  to  3297  millions  of  dollars,  and  in  this  same  year 
the  interest  on  funded  debt  and  dividends  amounted  to  666  mil- 
lions, or  20.2  per  cent  of  the  revenues  and  other  income.  This  rep- 
resents the  amount  accruing  to  the  stock  and  bondholders  as  joint 
owners  of  the  business,  not  counting  the  increase  in  surplus.  Is 
this  a  proper  payment  to  such  owners  ?  That  some  compensa- 
tion of  this  sort  is  necessary  under  the  regime  of  private  capi- 
talism is  clear,  for  if  none  were  made,  new  roads  would  not  be 
built  nor  would  old  ones  be  maintained.  A  common  answer  is 
that  the  owners  should  be  allowed  a  fair  return  upon  their 
investment,  but  it  is  difficult  to  say  what  is  a  fair  return  and  what 
is  the  actual  investment.  The  rate  of  interest  to  be  allowed 
must  be  determined  from  a  study  of  the  investment  market  and 
from  a  consideration  of  what  is  necessary  to  provide  a  surplus 
for  the  lean  years  and  for  unproductive  improvements. 

A  more  perplexing  question  is  to  decide  upon  a  fair  valua- 
tion upon  which  the  return  is  to  be  calculated.  Neither  the 
amount  of  stocks  and  bonds  nor  the  ledger  value  of  the  prop- 
erty is  a  safe  guide.  In  some  cases  the  actual  investment  may 
be  traced  historically  where  the  records  have  not  been  destroyed, 
but  this  raises  a  series  of  difficulties.  Was  the  investment 
wisely  made,  or  does  it  contain  a  large  profit  paid  to  some  con- 
struction company?  Should  investments  made  out  of  income 
or  surplus  be  distinguished  from  the  original  investment  or  from 
proceeds  of  the  sale  of  stock  and  bonds?  The  difficulty  of  as- 
certaining the  full  history  of  the  investment  has  led  to  estimates 
of  the  cost  of  the  production  or  reproduction  of  an  enterprise 
by  means  of  an  engineering  survey  of  the  road  and  equipment. 
The  Interstate  Commerce  Commission,  through  its  Division  of 
Valuation,  has  been  engaged  on  the  gigantic  task  of  making 


TRANSPORTATION   ECONOMICS  567 

a  valuation  of  the  entire  railway  system  of  the  United  States. 
Expensive  as  this  undertaking  is,  it  seems  to  be  the  only  hope 
of  reaching  an  equitable  determination  of  what  is  to  be  regarded 
as  a  fair  valuation  upon  which  to  base  rates.  Should  the  people 
of  the  United  States  ever  reach  the  conclusion  that  it  is  wise 
for  them  to  own  the  railways,  a  valuation  of  this  kind,  kept 
up  to  date  by  appropriate  accounting,  will  be  of  the  greatest 
benefit.  But  the  "  physical  ■"  or  engineering  valuation  itself 
will  not  answer  the  question  of  what  is  a  fair  value.  Shall  the 
"cost  new"  or  the  "depreciated  value"  be  taken?  To  what 
extent  shall  an  intangible  or  "  going  "  value  be  recognized? 

No  answer  of  universal  application  can  be  given  to  these  ques- 
tions, but  it  may  safely  be  said  that  when  a  depreciation  fund 
has  been  accrued  through  annual  charges  to  operating  expenses, 
the  amount  of  such  depreciation  must  be  deducted  from  the 
cost  new.  It  is  sometimes  said  that  if  we  deduct  depreciation 
we  must  also  add  appreciation,  but  this  is  taken  into  account  in 
the  method  by  which  valuations  are  usually  made,  that  is,  where 
real  estate  is  valued  according  to  the  selling  price  of  neighboring 
lands.  It  is  extremely  doubtful  whether  any  going  or  intangible 
value  should  be  recognized.  To  do  this  might  amount  to  re- 
warding a  railroad  for  becoming  a  monopoly.  The  case  is  some- 
what different  from  that  of  a  manufacturing  establishment  where 
its  "  good-will  "  may  frequently  be  developed  by  superior  skill 
in  the  face  of  competition. 

Relative  Rates.  —  When  the  general  level  of  rates  has  been 
determined  we  are  confronted  by  the  question  of  what  should  be 
charged  for  each  particular  shipment,  and  here  we  find  the  appli- 
cation of  the  principle  of  expense  of  still  greater  difficulty  and  un- 
certainty. In  attempting  to  say  what  it  costs  to  carry  a  ton  of 
coal  a  mile,  we  find  that  a  large  part  of  the  expenditure  is  incurred, 
not  for  one  specific  kind  of  commodity,  but  jointly  for  many 
kinds.  The  roadbed,  ties,  and  rails  are  maintained,  not  for 
coal  cars  alone,  but  for  passenger  trains  as  well.  Even  with  the 
most  careful  bookkeeping  it  is  possible  to  trace  a  direct  causal 
connection  between  only  a  part  of  the  expenses  and  specific 
portions  of  the  traffic.     It  is  possible  to  say  that  a  certain  traffic 


568  OUTLINES  OF  ECONOMICS 

requires  a  certain  amount  of  extra  labor  and  fuel,  and  causes  a 
certain  amount  of  wear  and  tear,  and  clearly  such  traffic  should 
normally  pay  enough  to  meet  these  expenses  at  least,  if  we  wish 
to  prevent  waste.  But  what  shall  be  done  with  such  joint  ex- 
penditures as  fall  under  the  head  of  maintenance  of  way  ?  Shall 
they  be  charged  to  the  freight  or  to  the  passenger  services  ?  The 
prevailing  opinion  has  been  that  the  cost  of  carrying  a  specific 
shipment  cannot  be  determined  with  sufficient  accuracy  for  any 
useful  purpose  because  the  element  of  "  joint  expense  "  is  said  to 
be  a  prominent  characteristic  of  the  production  of  railway  serv- 
ices. In  1894  the  National  Association  of  Railroad  Commis- 
sioners and  the  Interstate  Commerce  Commission  indorsed  the 
view  that  railroads  should  not  be  required  to  separate  the 
operating  expenses  of  their  freight  and  passenger  services.  Since 
that  time  there  has  been  a  great  development  among  manufac- 
turing enterprises  of  what  is  known  as  cost  accounting,  which  is 
concerned  with  the  apportionment  of  the  total  expenses  of  a 
factory  among  its  several  products.  This  has  been  found  use- 
ful both  in  matters  connected  with  the  fixing  of  prices  and  in 
determining  the  efficiency  of  the  various  departments  of  an 
enterprise.  Statistics  of  this  kind  were  also  developed  by  some 
railway  managements,  but  little  use  was  made  of  them  in  de- 
termining rates.  In  1907  the  railroad  commission  of  Wiscon- 
sin gave  an  impetus  to  railway  cost  accounting  by  its  opinion 
in  the  case  of  Buel  vs.  C.  M.  and  St.  P.  Railway,  where  the 
reasonableness  of  a  passenger  rate  of  three  cents  a  mile  had  been 
questioned.  A  complete  apportionment  was  made  of  the 
expenditures  of  this  railroad  between  its  freight  and  passenger 
services.  In  19 14  the  Interstate  Commerce  Commission  recon- 
sidered the  whole  matter,  and  after  a  public  hearing  decided  that 
in  the  future  railways  must  report  their  operating  expenses  sepa- 
rately for  freight  and  passenger  services  according  to  bases  to 
be  prescribed  by  the  commission.1 

Is  there  a  sound  theoretical  basis  for  this  newer  development  ? 
This  is  a  controverted  point  in  economic  theory  and  a  full  dis- 
cussion cannot  be  given  here.     What  has  been  said  in  Chapter 

1  fn  the  Matter  of  tlie  Separation  of  Operating  Expenses  (,30 1.  C.  C.  Reports,  676). 


TRANSPORTATION  ECONOMICS  569 

XI  regarding  constant  and  variable  expenses  and  joint  expenses 
of  production  should  be  reviewed  in  this  connection.  Within 
certain  limits  an  increase  in  the  volume  of  railway  traffic  results 
in  a  lower  average  outgo  per  unit  of  product  because  certain 
items,  such  as  maintenance  of  way  and  the  interest  on  the  in- 
vestment in  the  roadway,  do  not  grow  as  rapidly  as  the  traffic, 
not  to  mention  other  economies.  As  railways  can  classify  their 
traffic  by  commodities  and  points  of  origin  and  destination,  it 
will  pay  to  make  low  rates  on  traffic  which  would  not  otherwise 
be  secured.  But  it  is  superficial  to  stop  with  the  analysis  at  this 
point.  As  traffic  increases  the  tracks  and  bridges  are  strength- 
ened and  additional  tracks  are  added.  In  Uie  long  run  the 
amount  of  the  investment  is  markedly  affected  by  the  volume  of 
traffic;  that  is,  in  the  long  run  there  is  a  causal  connection  be- 
tween growth  in  volume  of  traffic  and  growth  in  maintenance 
and  interest  charges,  and  this  is  the  theoretical  basis  for  attempt- 
ing to  distribute  transportation  and  equipment  expenses  and  at 
least  a  part  of  the  maintenance  and  interest  charges  to  specific 
services.  As  a  matter  of  fact,  over  70  per  cent  of  all  of  the 
operating  expenses  can  be  directly  assigned  to  freight  service 
or  to  passenger  service  without  arbitrary  apportionments,  when 
the  accounting  is  arranged  for  that  purpose,  and  a  considerable 
part  of  the  investment  can  also  be  directly  assigned  to  one  serv- 
ice or  to  the  other.  The  kind  of  expenses  which  can  be  dis- 
tinguished as  between  freight  trains  and  passenger  trains  can  also 
logically  be  distinguished  as  between  different  classes  of  freight 
trains,  so  that  the  cost  of  hauling  a  trainload,  a  carload,  or  even 
a  ton  of  freight  a  mile  can  be  approximated.  If  any  class  of 
freight  traffic  or  passenger  traffic  cannot  bear  the  operating 
expenses  and  interest  charges  attributable  to  that  class  of  traffic, 
it  is  not  profitable  traffic. 

It  is  worth  noting  that  the  variety  of  railway  services  is  not 
nearly  so  great  as  might  be  imagined  from  the  multiplicity  of 
rates  in  existence.  Freight  transportation  consists  in  moving 
a  mass  of  material  in  freight  cars,  and  from  the  cost  standpoint 
it  makes  little  difference  whether  we  call  the  material  sand, 
cement,  or  iron  ore.     The  fact  that  commodities  vary  in  bulk 


570  OUTLINES   OF   ECONOMICS 

as  compared  wit!?  their  weight  is  not  an  insuperable  difficulty  in 
comparing  their  costs  of  transportation.  Forty  tons  of  coal 
can  be  loaded  in  one  car  while  forty  tons  of  bird  cages  might  re- 
quire forty  cars,  but  the  train  resistance  caused  by  a  car  and 
contents  in  each  case  can  be  measured  approximately. 

While  greater  emphasis  may  in  the  future  be  laid  on  the  cost 
principle,  rates  will  doubtless  continue  to  be  based  to  a  very 
large  degree  on  the  principle  of  "  charging  what  the  traffic  will 
bear."  Whether  because  of  past  commercial  developments  or 
for  reasons  of  public  policy,  some  traffic  will  be  carried  at  rates 
less  than  those  indicated  by  cost  considerations,  and  this  means 
that  other  traffic  will  have  to  bear  rates  higher  than  those 
indicated  by  considerations  of  cost.  Some  of  the  expenses  of 
every  railroad,  varying  in  some  degree  with  its  stage  of  develop- 
ment, may  even  in  the  long  run  be  regarded  as  independent  of 
the  traffic,  and  such  expenses  should  be  distributed  over  such 
traffic  as  can  best  bear  them.  In  the  construction  of  freight 
classifications,  the  value  of  a  commodity  itself  is  given  con- 
sideration as  a  measure  of '  what  the  traffic  can  bear  or  of  the 
"  value  of  the  service,"  but  it  is  clear  that  this  is  not  an  exact 
measure. 

Distance.  —  A  most  perplexing  factor  in  rate  making  is  that 
of  distance.  In  actual  practice,  distance  has  been  to  a  very  large 
degree  ignored.  For  example,  in  group  rates,  the  same  charge 
is  made  to  a  common  market  from  any  point  within  a  certain  area , 
irrespective  of  the  length  of  the  haul.  In  the  basing-point  system, 
the  rates  to  small  towns  in  a  certain  region  will  not  vary  accord- 
ing to  the  distance  from  the  point  of  shipment,  but  are  found 
by  adding  together  the  rate  to  a  railway  center,  called  a  basing 
point,  and  the  local  rate  from  this  basing  point  to  the  small  town, 
even  though  the  town  be  nearer  than  the  basing  point  to  the 
original  point  of  shipment.  Again,  goods  brought  from  a  for- 
eign country  to  a  point  in  the  interior  may  be  given  a  rate  lower 
than  the  domestic  rate  from  the  point  of  entry  to  the  same  point 
in  the  interior.  Again,  goods  intended  for  export  sent  from  Chi- 
cago to  New  York  may  pay  less  than  those  intended  for  use  in 
New  Y'rk.     Goods  are  sent  to  San  Francisco  from  New  York 


TRANSPORTATION   ECONOMICS  57 1 

for  less  than  the  rate  from  many  points  west  of  the  Mississippi 
River  to  San  Francisco.1  These  conditions  have  largely  grown 
out  of  the  competition  of  railways  among  themselves  and  with 
waterways. 

The  fact  that  distance  is  one  element  in  the  expense  of  carriage 
suggests  that  it  should  be  taken  account  of  in  making  rates, 
although  there  are  many  circumstances  which  necessitate  a  de- 
parture from  the  rule  of  a  strict  mileage  rate.  The  fact  that 
terminal  charges,  for  example,  are  the  same  for  a  long  as  for  a 
short  haul  justifies  a  decrease  in  the  total  charge  per  ton  mile  as 
distance  grows.  The  great  advantage  of  following  a  schedule  of 
rates  based  on  distance  is  that  it  affords  some  basis,  although  not 
an  absolute  guide,  for  settling  sectional  disputes  concerning 
relative  railway  charges. 

Government  Ownership  or  Government  Regulation  ?  —  With 
the  decline  of  competition  in  the  railway  business,  the  alternative 
lies  between  private  operation  with  government  supervision  on 
the  one  hand,  and  government  ownership  and  operation  on  the 
other.  There  cannot  be  said  to  be  any  well-defined  movement 
for  government  ownership  in  the  United  States.  Socialists  favor 
it  as  a  step  in  the  direction  of  their  ideals,  but  conservative 
persons  also  have  recognized  that  the  difficulty  of  regulating 
railroads  with  sufficient  stringency  to  prevent  abuses  and  at  the 
same  time  with  sufficient  freedom  given  to  railway  managements 
to  develop  their  properties  in  the  most  efficient  manner  may 
make  government  ownership  inevitable. 

No  convincing  argument  for  either  side  of  this  question  can 
be  made  by  comparing  the  quality  of  railroad  service  and  the 
rates  charged  in  countries  that  have  government  ownership  with 
the  service  and  rates  of  railways  privately  owned  and  managed. 
There  is  little  question  that  government  ownership  is  feasible 
in  this  country  and  that  good  service  might  be  expected.  Greater 
pains  might  be  taken  to  consider  public  convenience,  and  labor 
conditions  might  be  improved  for  the  lower  classes  of  employees. 

1  See  City  of  Spokane  v.  Northern  Pacific  Railway  Co.,  21  I.  C.  C.  400  and  23 
I.  C.  C.  454 ;  United  States  v.  Union  Pacific  Railroad  Co.,  234  U.  S.  495 ;  Commod- 
ity Rates  to  Pacific  Coast  Terminals  and  Intermediate  Points,  32  I.  C.  C.  611. 


572  OUTLINES  OF  ECONOMICS 

Personal  discrimination  might  be  expected  to  cease  altogether. 
It  has  been  suggested  that  rates  could  be  reduced  because,  owing 
to  the  superior  credit  of  the  United  States  government,  capital 
could  be  secured  at  a  lower  rate  of  interest.  But  it  is  difficult 
to  tell  to  what  extent  the  credit  of  the  government  might  be 
adversely  affected  by  the  issue  of  sufficient  bonds  to  purchase 
the  railways  of  this  country.  There  might  be  economies  in  the 
elimination  of  some  of  the  expenses  due  to  the  efforts  of  railways 
to  get  traffic  away  from  each  other,  to  roundabout  hauls,  and  to 
useless  duplication  of  facilities. 

The  political  consequences  might  be  unfavorable.  It  would 
be  unfortunate  to  have  sectional  disputes  as  to  rates  thrown 
into  politics.  Railroad  extensions  might  become  "  pork,"  like 
our  river  and  harbor  improvements.  The  voting  power  of 
railway  employees  might  be  sought  by  politicians  by  promises 
of  improved  conditions  of  work. 

A  most  serious  consideration  is  the  question  of  efficiency  of 
management.  A  private  and  a  public  monopoly  alike  may  be- 
come unprogressive.  It  may  be  that  our  system  of  regulation 
can  be  so  developed  that  it  will  serve  at  once  as  a  check  upon  abuses 
and  as  a  stimulus  to  efficiency.  It  is  not  always  best  to  decide 
today  what  can  as  well  be  decided  tomorrow.  Whether  or  not 
government  ownership  is  coming,  the  perfection  of  the  govern- 
ment control  of  our  private  railways  would  seem  to  be  the  wisest 
next  step.  Government  regulation  has  already  accomplished 
much  in  the  United  States.  It  has  nearly  eliminated  rebates 
and  personal  discrimination ;  it  has  given  stability  to  rates ;  it 
has  strengthened  railway  credit ;  it  has  promoted  uniformity  in 
accounting ;  it  has  shown  that  it  can  raise  rates  as  well  as  lower 
them  and  that  it  can  settle  sectional  disputes  as  to  rates  in  a  com- 
prehensive way.  There  still  remains  the  task  of  determining  the 
amount  of  railway  investment  entitled,  to  a  return,  of  devising 
a  proper  control  over  capitalization,  of  perfecting  the  rate 
-system,  and  of  working  out  comparative  standards  of  effi- 
ciency. We  may  well  hope  that  government  ownership  will  at 
least  be  deferred  until  more  has  been  accomplished  along  these 
lilies. 


TRANSPORTATION  ECONOMICS  573 

Government  Regulation  of  Railways  in  the  United  States.  — 
Railway  corporations  in  the  United  States  are  almost  all  organ- 
ized under  the  laws  of  the  separate  states.  Formerly  special 
laws  were  passed  when  a  railway  company  was  to  be  formed,  but 
at  the  present  time  there  are  general  laws  specifying  what  con- 
ditions must  be  complied  with  in  order  that  a  number  of  persons 
may  organize  a  railway  corporation.  The  separate  states  have 
imposed  a  number  of  regulations  and  restrictions  not  only  on  the 
companies  which  they  have  chartered  but  also  on  others  doing 
business  within  their  borders.  These  relate  to  the  safety  and 
the  comfort  of  passengers,  train  service,  consolidations,  pooling, 
ticket-scalping,  discriminations  between  shippers  and  places, 
the  issue  of  securities,  and  reasonableness  of  charges.  Railway 
or  public  service  commissions  are  found  in  all  but  a  few  states. 

That  a  railway  corporation  is  subject  to  government  regulation 
in  the  interest  of  the  public  welfare  has  been  clearly  established 
by  a  long  line  of  judicial  decisions  beginning  with  the  leading 
"  Granger  "  case  of  Munn  vs.  Illinois.1  But  the  authority  of 
the  state  governments  has  been  greatly  limited  by  two  provisions 
in  the  federal  Constitution.  Congress  having  been  given  control 
over  interstate  commerce,  the  states  must  confine  themselves  in 
their  regulations  to  commerce  wholly  within  the  state.  And 
the  Fourteenth  Amendment  declares  that  no  state  shall  deprive 
any  person  of  life,  liberty,  or  property  without  due  process  of  law 
or  deny  to  any  person  within  its  jurisdiction  the  equal  protec- 
tion of  the  law.  The  courts  have  interpreted  this  provision  to 
mean  that  neither  a  state  legislature  nor  a  commission  created 
by  it  can  fix  rates  even  on  intrastate,  traffic  without  a  review  by 
the  courts.  The  courts  have  often  declared  rate  legislation  by 
states  void  on  the  ground  that  it  confiscated  the  property  of  the 
stockholders.2 

Federal  regulation  of  railways  is  based  on  the  Interstate 
Commerce  Act  of  1887,  which  has  been  repeatedly  amended, 
most  extensively  in  1906  and  1910.  The  following  is  a  summary 
of  the  amended  act,  as  in  force  in  19 16 : 

1 94  U.S.  113(1876). 

*  The  Fifth  Amendment  imposes  similar  limitations  upon  the  federal  government 


574  OUTLINES  OF   ECONOMICS 

The  Interstate  Commerce  Commission  consists  of  seven  mem- 
bers appointed  by  the  President  with  the  "  advice  and  consent  " 
of  the  Senate,  with  terms  of  seven  years,  not  more  than  four  of 
the  commissioners  being  from  the  same  political  party.  The 
jurisdiction  of  the  commission  extends  not  only  over  steam  rail- 
ways but  also  over  electric  railways,  telegraph,  telephone,  and 
cable  companies,  pipe  lines,  express  and  sleeping  car  companies, 
and  to  some  extent  over  water  carriers.  The  control  in  these 
cases  extends  to  interstate  traffic  merely. 

\\l  charges  and  practices  must  be  reasonable,  but  no  general 
standards  of  reasonableness  have  been  prescribed  by  Congress. 
Certain  specific  things  are  prohibited.  There  can  be  no  dis- 
crimination between  persons  or  places  and  no  free  passes  or  free 
transportation  except  to  classes  of  persons  specified  in  the  act. 
The  giving  of  rebates  renders  both  shipper  and  carrier  liable 
to  punishment.  Pooling  is  prohibited,  and  no  railway  may 
have  any  interest  in  any  competing  water  carrier.  When  rates 
have  been  reduced  to  meet  water  competition  they  may  not 
be  raised  again  without  permission.  No  common  carrier  may 
make  any  greater  charge  for  a  shorter  than  for  a  longer  dis- 
tance in  the  same  direction,  the  shorter  being  included  within 
the  longer,  unless  authorized  to  do  so  by  the  commission. 
Carriers  must  file  with  the  commission  copies  of  all  their  rates 
and  fares,  and  no  carrier  may  make  charges  different  from  these 
published  rates.  Changes  in  rates  require  thirty  days'  notice 
unless  a  shorter  time  is  permitted  by  the  commission.  The 
commission  may  suspend  rates  for  a  period  of  120  days  and  a 
further  period  of  six  months. 

Any  person  may  make  a  complaint  regarding  rates  or  prac- 
tices and  the  commission  may  institute  inquiries  on  its  own  mo- 
tion. It  has  power  to  fix  maximum  rates  for  a  period  of  two 
years  and  may  award  reparation  to  shippers  who  have  been 
overcharged.  The  orders  of  the  commission  may  be  reviewed 
by  the  courts  as  to  questions  of  law  but  not  as  to  findings  of  fact. 
A  Commerce  Court  was  created  in  1910  to  hear  appeals  from  the 
commission's  orders  but  this  court  was  abolished  in  1913,  its 
jurisdiction  being  vested  in  the  several  district  courts. 


TRANSPORTATION   ECONOMICS  575 

Section  20  of  the  act  empowers  the  commission  to  require 
annual  and  special  reports  from  transportation  companies  and 
to  prescribe  the  form  of  the  accounts  which  may  be  kept.  Under 
this  provision  uniform  classifications  of  accounts  have  been 
worked  out  in  cooperation  with  railway  accountants. 

In  1913  Congress  directed  the  commission  to  ascertain  the 
value  of  all  the  property  of  every  common  carrier  subject  to  the 
act.  As  to  every  piece  of  property  there  is  to  be  ascertained 
the  original  cost  to  date,  the  cost  of  reproduction  new,  the  cost 
of  reproduction  less  depreciation,  and  other  values,  if  any.  In 
1 9 14  the  commission  was  given  authority  to  enforce  the  Clayton 
Anti- trust  Act  so  far  as  it  applies  to  common  carriers.  The 
main  purpose  of  this  part  of  the  act  is  to  prevent  those  inter- 
corporate relationships  which  tend  to  lessen  competition. 

The  commission  is  also  charged  with  the  enforcements  of 
safety  appliance  and  boiler  inspection  provisions  and  with 
matters  relating  to  hours  of  service  of  employees  and  to  railway 
accidents. 

The  Interstate  Commerce  Commission  regularly  employs  about  700 
persons,  but  the  work  of  valuation  has  temporarily  greatly  increased  this 
number.  A  general  survey  of  its  work  each  year  is  given  in  its  Annual  Report 
to  Congress.  Its  30  or  more  volumes  of  decisions,  published  as  the  Inter- 
state Commerce  Commission  Reports,  contain  a  vast  amount  of  descriptive 
material  concerning  the  rate  structures  and  the  practices  of  railways  in  the 
United  States.  Information  concerning  the  mileage,  capitalization,  reve- 
nues, expenses,  and  traffic  of  railways  will  be  found  in  its  annual  volume  called 
Statistics  of  Railways  in  the  United  Stales. 

QUESTIONS  AND  EXERCISES 

1.  Write  a  description  of  some  railway  system,  giving  its  organization, 
capitalization,  earnings,  dividends,  nature  of  traffic,  territory  covered,  etc. 

2.  Make  a  digest  of  the  opinions  in  the  Northern  Securities  Case,  193 
U.  S.  197,  and  the  United  States  vs.  The  Union  Pacific  Railroad  Company, 
226  U.  S.  61. 

3.  If  you  have  paid  $200  for  a  share  of  stock  in  a  monopolistic  enter- 
prise, have  you  a  right  to  complain  if  government  regulation  so  affects  its 
earnings  that  the  price  of  the  share  falls  to  $100? 

4.  Discuss  the  conflict  of  authority  between  state  and  federal  commis- 
sions (Shreveport  Cases,  234  U.  S.  342). 


576  OUTLINES  OF   ECONOMICS 

5.  Can  one  ascertain  what  it  costs  the  railways  to  carry  United  States 
mails? 

6.  Can  the  passenger  service  be  said  to  be  a  by-product  of  the  freight 
service  ? 

7.  Compare  some  of  the  leading  railways  from  the  standpoint  of  density 
of  traffic. 

8.  What  would  be  the  economic  effects  of  a  "  postage-stamp  "  railway  rate 
system,  in  which  rates  vary  with  the  weight  and  nature  of  the  shipment, 
but  not  with  distance  ? 

REFERENCES 

Acworth,  W.  M.     Elements  of  Railway  Economics. 

Bureau  of  Corporations.     Report  on  Transportation  by  Water,  1909,  1910. 

Hammond,  M.  B.  Railway  Rate  Theories  of  the  Interstate  Commerce  Commis- 
sion. 

Interstate  Commerce  Commission.  Annual  Reports ;  I.  C.  C.  Reports; 
Statistics  of  Railways  in  the  United  States. 

Johnson,  E.  R.  American  Railway  Transportation;  Ocean  and  Inland 
Water  Transportation:  Report  on  Panama  Canal  Traffic  and  Tolls. 

Johnson,  E.  R.,  and  Huebner,  G.  G.     Railroad  Traffic  and  Rates  (2  vols.). 

Joint  Committee  on  Federal  Aid  in  the  Construction  of  Post  Roads.  Re- 
port (1914). 

McPherson,  L.  G.  Railroad  Freight  Rates  in  Relation  to  Industry  and 
Commerce. 

Meyer,  B.  H.    Railway  Legislation  in  tlie  United  States,  Part  ii. 

Morris,  Ray.    Railroad  Administration. 

Moulton,  H.  G.     Waterways  versus  Railways. 

National  Waterways  Commission.     Report  (1009). 

PiGor,  A.  C.     Wealth  and  Welfare,  Chap.  xiii. 

Ripley,  W.  Z.  Railroads:  Rates  and  Regulation;  and  (editor)  Railway 
Problems. 

Sakolski,  A.  M.     American  Railroad  Economics.     Chap.  hi. 

Smith,  J.  R.     The  Ocean  Carrier. 

Vroom\n,  C.  S.     American  Railway  Problems. 

Webb,  W.  L.    Economics  of  Railroad  Construction,  Part  i. 


CHAPTER  XXVIII 
INSURANCE 

Nature  of  Insurance.  —  The  essential  idea  of  the  modern  in- 
stitution of  insurance  is  cooperation  in  the  bearing  of  losses  which 
are  likely  to  happen  to  any  one  of  a  large  group  of  persons  but 
which  will  actually  fall  upon  but  few  members  of  the  group.  It 
is  thus  directly  opposed  to  gambling,  although  wagers  have  fre- 
quently been  made  in  the  form  of  the  insurance  contract.  It 
may  appear  at  first  that  the  man  who  insures  his  house  is 
making  a  wager  with  the  insurance  company  that  his  house  will 
burn,  but  this  is  in  fact  like  betting  on  both  sides  of  an  event. 
If  the  man  does  not  insure,  he  may  be  regarded  as  betting  that 
his  house  will  not  burn,  and  by  wagering  with  the  insurance  com- 
pany that  it  will  burn,  he  relieves  himself  of  risk.  For  this  relief 
he  is  willing  to  incur  the  certain  loss  of  his  premium.  Insurance 
does  not  free  the  policy  holders  from  loss,  but  it  means  many 
small  losses  in  place  of  a  few  unbearable  ones.  In  well-devel- 
oped forms  of  insurance  there  is  also  no  risk  for  the  insurance 
company,  because  the  amount  of  loss  is  approximately  known  in 
advance,  as  will  be  explained  presently. 

The  question  is  sometimes  asked  whether  insurance  is  pro- 
ductive in  the  sense  that  other  economic  activities  are  productive. 
The  answer  is  decidedly  in  the  affirmative,  for  the  feeling  of 
security  that  it  makes  possible  is  a  real  satisfaction  which  we  are 
willing  to  purchase.  Then  too,  there  is  a  very  important  eco- 
nomic gain  in  distributing  among  many  persons  the  burden  of 
losses  which  would  otherwise  fall  heavily  upon  a  few.  Further- 
more, the  relief  of  distress  among  the  unfortunate  without  com- 
pelling them  to  accept  charity  is  a  distinct  social  gain,  and 
finally,  many  of  our  business  operations  are  facilitated  by  the 
**  577 


578  OUTLINES   OF   ECONOMICS 

existence  of  a  system  of  insurance.  Prevention  of  loss  is  not 
properly  a  part  of  the  idea  of  insurance,  but  nevertheless  insur- 
ance as  it  exists  today  does  have  many  tendencies  in  that 
direction,  especially  in  such  forms  as  fire  and  steam-boiler  in- 
surance. On  the  other  hand,  insurance  causes  a  certain  amount 
of  loss  by  provoking  to  some  extent  incendiarism,  self -mutilation, 
or  suicide,  and  even  normal  persons  are  likely  to  be  less  careful 
when  they  know  they  are  insured.  On  the  whole,  however,  we 
can  scarcely  overestimate  the  importance  to  society  of  an  in- 
stitution which  equalizes  economic  shocks  and  multiplies  the 
incentives  to  thrift. 

The  Law  of  Probabilities.  —  A  special  profession  (that  of  the 
actuary)  and  a  special  branch  of  mathematics  have  grown  up  as 
a  basis  of  the  institution  of  insurance.  It  is  a  knowledge  of  the 
law  of  large  numbers  that  changes  insurance  from  a  wager  to  a 
business  of  a  routine-like  nature.  If  a  coin  is  tossed  a  large  num- 
ber of  times,  heads  will  appear  about  as  often  as  tails.  This  may 
be  counted  upon  as  practically  certain,  but  with  respect  to  any 
particular  throw  taken  by  itself,  there  is  no  way  of  telling  in  ad- 
vance whether  heads  or  tails  will  appear.  This  truth  has  been 
worked  out  and  applied  most  definitely  to  life  insurance,  but  in 
other  business  callings  also  an  effort  is  made  to  gather  data  that 
will  make  possible  the  formulation  of  statistical  laws  as  guides 
in  making  business  plans. 

Origin  and  Development.  —  Arrangements  embodying  the 
idea  of  insurance  are  found  among  the  ancients,  but  the  modern 
institution  of  insurance,  although  its  origin  is  obscure,  first  be- 
comes prominent  in  the  loans  on  bottomry  which  became  com- 
mon during  the  thirteenth  and  fourteenth  centuries.  A  loan  on 
bottomry  meant  that  money  was  borrowed  by  the  owner  of  a  ship 
and  was  to  be  repaid  with  interest  at  the  termination  of  his 
voyage,  but  the  principal  and  interest  were  not  to  be  repaid  if 
the  ship  was  lost.  Sometimes  this  took  the  form  of  insuring 
the  captain's  life,  but  no  scientific  system  of  life  insurance  ap- 
peared until  the  compilation  of  life  tables. 

Fire  insurance  received  an  impetus  from  the  Great  Fire  of 
London  in  1666,  the  first  company  organized  upon  strict  mer- 


INSURANCE  579 

cantile  principles  being  the  "  Fire  Office,"  organized  in  1680.  It 
had  a  brigade  of  its  own  to  prevent  and  extinguish  fires.  In 
1693  Edmund  Halley  made  a  report  to  the  Royal  Society  regard- 
ing the  mortality  at  various  ages  upon  the  basis  of  tables  of 
births  and  funerals  at  the  city  of  Breslau ;  but,  practically,  life 
insurance  as  a  business  dates  from  the  organization  of  the  "  Old 
Equitable  "  in  1762. 

Before  this,  however,  there  were  many  associations  for  conducting  in- 
surance upon  a  speculative  basis,  which  entered  into  wagers  of  every  con- 
ceivable description.  "Even  the  morality  of  the  newspapers  cf  that  day 
was  shocked  by  such  proceedings :  we  find  the  London  Chronicle  of  1 768 
thus  declaiming,  'The  introduction  and  amazing  progress  of  illicit  gaming 
at  Lloyd's  Coffee-house,  is  among  others,  a  powerful  and  very  melancholy 
proof  of  the  degeneracy  of  the  time.  Though  gaming  in  any  degree  is  per- 
verting the  original  and  useful  design  of  that  Coffee-house,  it  may  in  some 
measure  be  excusable  to  speculate  on  the  following  subjects:  —  Mr.  Wilkes 
being  elected  member  for  London;  which  was  done  from  5  to  50  guineas 
per  cent.;  —  Mr.  Wilkes  being  elected  member  for  Middlesex,  from  20  to 
70  guineas  per  cent ;  —  Alderman  Bond's  life  for  one  year,  now  doing  at  7  per 
cent ;  —  On  Sir  J.  H.  [mark  the  modesty]  being  turned  out  in  one  year,  now 
doing  at  12  guineas  per  cent;  —  On  John  Wilkes'  life  for  one  year,  now 
doing  at  five  per  cent.  N.B.  —  Warranted  to  remain  in  prison  during  that 
period;  —  On  a  declaration  of  war  with  France  or  Spain  in  one  year,  S 
guineas  per  cent.  But,'  continues  the  sensitive  journalist,  'when  policies 
come  to  be  opened  on  two  of  the  first  peers  in  Britain  losing  their  heads 
at  10s.  6d.  per  cent,  or  on  the  dissolution  of  the  present  parliament  within 
one  year  at  5  guineas  per  cent.,  which  are  now  actually  doing,  and  under- 
written chiefly  by  Scotsmen,  at  the  above  Coffee-house,  it  is  surely  high  time 
to  interfere.'"  1 

In  the  United  States,  fire  insurance  was  fairly  well  begun 
even  in  pre-revolutionary  days.  In  1830  the  New  York  Life 
and  Trust  Company  was  organized,  and  twelve  years  later  ap- 
peared the  Mutual  Life  Insurance  Company  of  New  York, 
which  is  the  oldest  of  the  existing  American  life  insurance  com- 
panies which  insure  more  than  a  restricted  class  of  individuals. 
In  the  seventies  numerous  failures  brought  the  •"  old  line  "  life 
insurance  companies  into  discredit,  and  in  the  following  years 
this  fact,  together  with  the  desire  for  cheap  insurance,  caused 

1  Walford,  The  Insurance  Guide  and  Handbook,  4th  ed.,  p.  2' 


580  OUTLINES  OF  ECONOMICS 

a  marked  development  of  assessment  insurance,  against  which 
there  has  in  turn  been  a  reaction  because  of  its  unscientific  basis. 
Subsequently  the  "  old  line  "  companies  again  suffered  a  loss  of 
prestige  on  account  of  the  scandalous  extravagance  and  corrup- 
tion revealed  by  official  investigations.  The  evil  practices  had 
to  do  chiefly  with  the  management  of  the  surplus,  which  was  not 
under  legal  control  as  was  the  reserve.  (These  terms  will  be  ex- 
plained presently.)  The  accompanying  table  shows  the  growth 
in  American  life  insurance  since  1850.  The  check  in  1880  may 
be  noted.  Between  1890  and  1910  the  total  amount  of  life  in- 
surance in  force  in  ordinary  and  industrial  companies  increased 
fourfold.  The  average  amount  in  force  per  family  was  $319 
in  1890  and  $801  in  1910.  It  is  perhaps  needless  to  state  that 
the  average  amount  per  policy  is  much  larger  than  this  in 
ordinary  though  not  in  industrial  insurance.  The  foregoing 
does  not  include  the  insurance  fraternal  orders,  which  had 
10,122,169  certificates  and  $9,839,909,282  of  insurance  in  force 
in  1911. 

Forms  of  Insurance  Organization.  —  Fire  insurance  may  be 
written  by  stock  companies,  by  mutual  companies,  or  by  associa- 
tions of  individual  insurers,  known  as  underwriters  and  Lloyds. 
Mutual  companies,  again,  may  be  either  local  (county  or  town) 
mutuals,  state  or  general  mutuals,  or  the  manufacturers'  mutuals. 
The  local  town  mutuals  have  the  advantage  that  they  can  be 
conducted  with  a  very  low  cost  of  administration,  but  the  stock 
companies  seem  best  adapted  to  the  business  of  fire  insurance, 
since  it  is  desirable  that  the  risk  of  a  conflagration  should  be 
spread  over  a  very  wide  territory. 

Life  companies  are  also  found  both  in  the  stock  and  mutual 
form.  Theoretically  the  management  of  the  latter  is  in  the 
hands  of  the  policy  holders  themselves,  but  in  actual  practice 
they  must  be  managed  by  a  small  group  of  financiers.  Life  in- 
surance companies  are  also  classified  according  to  the  plans  of 
premium  payments :  (1)  "  old  line  "  level  premium,  (2)  assess- 
ment, and  (3)  stipulated  premium. 

Where  risk  enters  in  modern  life,  companies  are  often  organized 
to  offer  an  escape  from  it  through  insurance  even  before  enough 


INSURANCE 


58i 


data  have  been  collected  to  make  possible  the  accurate  predic- 
tion of  the  amount  of  loss.  In  addition  to  life  insurance  we  have 
indemnity  in  case  of  sickness,  accident,  destruction  by  fire, 
wind,  hail,  or  explosions  of  boilers  or  fly  wheels,  broken  windows, 

Number  of  Policies  and  Amount  of  Life  Insurance  in  Force  in 
Ordinary  and  Industrial  Companies,  1850  to  191 2  ' 


Ordinary 

Industrial 

Calendar 
Year 

Number  of 
Policies 

Amount  (Dollars) 

1 

Number  of 
Policies 

Amount  (Dollars) 

1850 

29,407 

68,614,189 

— 

— 

i860 

60,000 

180,000,000 

— 

— 

1870 

839,226 

2,262,847,000 

.   — 

— 

1880 

685,531 

1,581,841,706 

236,674 

20,533,469 

1890 

I,3I9»S6l 

3,620,057,439     ' 

3,882,914 

428,789,342 

1895 

1,940,945 

4,917,694,131     J 

6,952,794 

820,746,562 

1900 

3^76,051 

7,093,152,380 

11,219,296 

1,468,928,342 

I905 

5»62I,4I7 

11,054,255,524 

16,872,583 

2,309,754,235 

1910 

6,954,H9 

13,227,213,168 

23,044,162 

3,179,489,541 

1912 

8,159,103 

15,555,901,171 

26,521,655 

3,684,054,893 

and  loss  from  burglary  or  the  unfaithfulness  of  employees.  Li- 
ability insurance  in  over  a  dozen  different  forms  guards  against 
loss  from  damage  suits.  It  is  impossible  to  take  up  the  problems 
that  are  peculiar  to  each  one  of  these  branches,  and  attention  will 
be  confined  to  some  of  the  leading  features  of  life  insurance  and 
of  what  is  called  social  insurance. 


Life  Insurance 

Life  Tables.  —  A  life  table  or  mortality  table  shows  how  many 
of  a  large  group  of  persons  of  the  same  age  will  survive  to  each 
higher  age.  A  number  of  these  tables  have  been  calculated, 
but  the  one  generally  used  in  this  country  is  the  American  Ex- 
perience table,  a  portion  of  which  is  here  reproduced : 

1  Statistics  from  the  Insurance  Year  Book. 


582 


OUTLINES  OF   ECONOMICS 


Age 

Living  at  Beginning  of  Year 

Dying  during  the  Year 

IO 

100,000 

749 

II 

99,251 

746 

12 

98,505 

743 

13 

97,762 

740 

14 

97,022 

737 

IS 

96,285 

735 

16 

95,55° 

732 

17     - 

94,818 

729 

18 

94,089 

727 

19 

93,362 

725 

* 

* 

* 

90 

847 

385 

9i 

462 

246 

92 

216 

137 

93 

79 

58 

94 

21 

18 

95 

3 

3 

With  such  data  and  with  an  assumed  rate  of  interest  and  ex- 
pense, it  is  possible  to  say  with  considerable  certainty  how  much 
money  must  annually  be  collected  from  the  policy  holders  in 
order  to  pay  each  one  $1000  or  other  specified  sum  at  death. 

Premium  Plans.  —  It  would  be  possible  to  collect  from  those 
surviving  at  each  age  enough  money  to  pay  for  the  deaths  that 
would  happen  during  the  ensuing  year.  This  step  rate  or  natural 
premium  plan  necessitates  a  larger  and  larger  assessment  with 
advancing  age ;  that  is,  as  the  earning  power  of  the  insured  is 
declining.  This  induces  many  persons  who  continue  in  good 
health  to  discontinue  their  insurance,  thus  leaving  only  an  "  ad- 
verse selections  of  risks  "  for  the  insurance  company  or  associ- 
ation. It  has  become  customary  to  arrange  the  payments  on 
what  is  known  as  the  level  premium  plan,  the  same  annual  pay- 
ment being  made  throughout  the  life  of  the  policy.  This  pay- 
ment may  be  on  the  ordinary  life  plan,  that  is,  the  payments 
continue  throughout  life ;  or  ten,  fifteen,  or  twenty  limited  pay- 
ments may  be  made,  the  policy  continuing  in  force  for  life; 


INSURANCE  583 

or  the  insurance  may  be  for  only  a  term  of  years  during  which 
the  premiums  are  paid,  the  insurance  ceasing  entirely  at  the 
end  of  the  term.  This  is  the  cheapest  kind  of  insurance,  for 
the  insurance  company  knows  that  many  of  the  insured  will 
survive  beyond  the  term,  and  to  them  no  payment  need  be 
made,  but  when  the  insurance  continues  for  life,  the  payment 
becomes  a  certainty  in  every  case. 

The  Reserve.  —  If  a  level  premium  is  charged,  the  income  of 
the  company  in  the  earlier  years  of  a  policy  exceeds  the  expense 
of  carrying  the  risk,  as  measured  by  the  losses  on  account  of  the 
deaths  among  the  policy  holders  of  like  age.  The  portions  of  the 
premium  not  currently  used  must  be  held  for  the  credit  of  the 
policy  holder  until  the  later  years,  a  certain  rate  of  interest  being 
allowed.  This  accumulating  fund  is  known  as  the  reserve.  In 
the  later  years  of  the  life  of  a  policy,  the  reserve  is  gradually 
drawn  upon  to  meet  the  deficit  arising  from  the  fact  that  in 
these  years  the  level  premium  payments  will  be  insufficient  to 
meet  the  cost  of  carrying  the  risk,  —  smaller,  that  is,  than  they 
would  have  been  under  the  step  rate  or  natural  premium  plan. 

Surplus.  —  If  the  insured  live  longer  than  was  assumed  by 
the  company  in  calculating  its  premiums,  more  money  will  be 
collected  than  is  necessary  to  meet  the  obligations  of  the  insur- 
ance contracts.  This  is  one  source  of  surplus.  Again,  the 
funds  held  in  trust  by  the  company  may  be  invested  at  a  higher 
rate  of  interest  than  was  assumed  in  the  calculations,  and  this  is 
a  second  source  of  surplus.  A  third  source  of  surplus  is  in  keep- 
ing expenses  below  what  was  assumed  in  the  calculations.  (The 
addition  which  is  made  to  the  net  premium  to  cover  expenses  is 
called  "loading," and  is  commonly  not  far  from  a  fourth  of  the 
gross  premium.)  The  amounts  paid  in  by  those  who  subse- 
quently lapse  or  surrender  their  policies  do  not  all  go  to  the 
surplus,  for  it  is  customary  now  to  allow  "surrender  values" 
and  "paid-up  insurance  "  ;  but  as  these  allowances  are  subject 
to  a  surrender  charge,  there  is  some  addition  to  the  surplus 
from  the  surrendered  or  lapsed  policies.  Out  of  the  surplus  are 
paid  the  dividends  on  the  capital  stock,  if  there  be  any,  and 
the  dividends  to  each  policy  holder,  which  in  some  cases  are 


584  OUTLINES  OF   ECONOMICS 

credited  or  paid  annually  to  each  policy  holder,  but  in  other 
cases  not  until  the  expiration  of  a  period  of  years. 

Endowments.  —  What  is  ordinarily  called  an  endowment 
policy  is  a  combination  of  two  distinct  forms  of  contract.  A 
simple  life  insurance  contract  promises  to  pay  a  certain  sum 
upon  the  death  of  the  insured ;  a  pure  endowment  contract  would 
pay  a  certain  sum  if  the  holder  of  the  policy  survives  after  a 
period  of  years.  A  twenty-year  endowment  insurance  policy 
combining  these  two  features  means  that  payment  would  be 
made  at  death  if  that  occurred  within  the  twenty  years,  or  at  the 
expiration  of  twenty  years  if  the  policy  holder  survives. 

This  form  of  policy  has  been  declining  in  popularity  because 
in  its  ordinary  form  it  is  disadvantageous  to  the  policy  holder, 
unless  he  be  so  thriftless  that  he  cannot  be  induced  to  save  in  any 
other  way.  If  insurance  could  not  be  obtained  in  any  other 
way,  it  might  be  wise  to  purchase  such  a  policy,  but  the  objects 
of  saving  and  insuring  can  be  more  cheaply  accomplished  by 
separating  the  two  features.  If,  instead  of  paying  $50  for  an 
endowment  policy,  the  holder  paid  part  of  this  for  term  insurance 
and  put  the  remainder  in  a  savings  bank  at  three  or  four  per  cent 
compound  interest,  there  might  be  more  to  his  credit  whether 
he  lived  or  died.  But  when  the  loading  is  properly  arranged, 
and  with  an  annual  distribution  of  surplus,  the  endowment  policy 
performs  a  useful  function  as  an  encouragement  of  thrift.  In 
fact,  a  very  long-term  endowment  maturing  at,  say,  age  sixty- 
five,  would  best  meet  the  needs  of  a  great  many  persons.  Many 
others,  feeling  that  they  lack  the  necessary  determination  to  save 
regularly  a  portion  of  their  incomes  in  the  ordinary  way,  find 
the  endowment  policy  a  useful  form  of  "  compulsory  saving." 

These  points  will  be  made  clearer  by  the  following  illustration 
of  what  becomes  of  the  premium  in  the  case  of  a  ten-year  endow- 
ment policy  at  age  thirty-five  with  a  premium  of  $107.70,  when 
it  is  assumed  that  the  mortality  will  be  in  accordance  with  the 
American  Experience  Table,  that  the  company  will  earn  three 
per  cent  on  its  funds,  and  that  the  expense  charged  each  year  to 
this  policy  will  be  as  given  in  the  table.1 

1  Report  of  the  Wisconsin  Joint  Legislative  Investigating  Committee,  1006,  p.  153. 


INSURANCE 


585 


Policy  Year 

Expense  Charge 

Mortality  Charge 

Deposit 

1 

$  18.40 

$7.96 

$    81.34 

2 

18.40 

7-31 

165-77 

3 

18.40 

6.62 

253-42 

4 

18.40 

5-80 

344-43 

5 

18.40 

5-io 

438.96 

6 

18.40 

4.26 

537-17 

7 

18.40 

3-32 

639.27 

8 

18  40 

2.32 

745-43 

9 

18.40 

1. 21 

855-89 

10 

18.40 

— 

970.87 

Totals 

$  184.00 

$43-99 

Industrial  Insurance.  —  The  business  of  insuring  the  lives  of 
workingmen  in  this  country  is  characterized  by  the  small  size 
of  the  average  policy,  the  large  number  of  lapses,  and  the  heavy 
expense  of  solicitation.  The  companies  say  that  the  working- 
man  is  so  thriftless  that  it  is  necessary  to  collect  the  premiums 
through  a  house-to-house  canvass  by  agents.  The  hesitancy 
shown  by  workingmen  to  insure  in  these  companies  is  considered 
by  some  persons,  however,  as  an  evidence  of  their  thrift.  Which 
is  the  correct  view  may  be  shown  by  the  results  of  an  experiment 
which  is  now  being  iiiad  in  the  state  of  Massachusetts.  Savings 
banks  have  been  au;ncrized  to  organize  insurance  departments 
and  to  sell  life  insuiance,  but  without  employing  paid  agents  or 
solicitors.  The  state  bears  the  actuarial,  medical,  and.  certain 
other  expenses.  The  workingman  is  expected  to  go  of  his  own 
accord  to  the  bank  or  to  one  of  the  agencies  at  convenient  places. 
The  whole  system  is  supervised  by  a  state  actuary  and  a  state 
medical  director,  and  the  safety  of  the  plan  is  assured  by  a  guar- 
antee fun^.  Three  forms  of  policies,  limited  to  S500  each,  are 
provided  for :  ordinary  life  insurance,  endowment,  and  a  com- 
bination of  life  insurance  and  old-age  annuity.  The  plan  has 
met  with  some  success,  but  is  still  in  an  experimental  stage. 

State  Insurance.  —  Insurance  is  well  adapted  to  direct  man- 
agement by  the  State  because  the  actual  conduct  of  the  business 


586  OUTLINES  OF   ECONOMICS 

is  of  a  relatively  simple  and  routine  character  and  because  the 
State  can  offer  greater  security  and  can  command  greater  confi- 
dence than  is  possible  in  the  case  of  a  private  corporation.  Com- 
petition has  had  the  effect  of  causing  rival  companies  to  invent 
many  outwardly  attractive  combinations  of  policy  conditions, 
but  on  the  whole  it  has  increased  rather  than  decreased  the  ex- 
pense of  doing  the  business.  When  the  State  enters  the  field 
simply  as  an  additional  competitor,  as  in  New  Zealand,  its  full 
advantage  is  not  apparent ;  but  if  it  has  a  monopoly  of  the  busi- 
ness and  compels  every  one  to  insure,  it  can  perhaps,  without 
any  setection  of  risks,  effect  the  insurance  at  a  lower  price  than 
is  asked  by  any  existing  private  company.1  In  19 13  the  state 
of  Wisconsin  began  the  sale  of  life  insurance.  The  main  object 
of  the  law  is  the  reduction  in  the  cost  of  insurance  by  reducing 
the  expense  of  solicitation  and  administration.  The  credit  of 
the  state  is  involved  only  to  the  extent  of  the  life  fund  created  by 
the  insurance  act.     In  Italy  life  insurance  is  a  state  monopoly. 

State  Regulation.  —  Following  the  example  of  Massachusetts 
in  1858,  other  states  have  appointed  insurance  commissioners 
for  the  supervision  of  this  business,  and  the  insurance  laws  of 
a  single  one  of  these  states  are  now  sufficient  to  make  a  good- 
sized  volume.  Insurance  companies  have  found  this  variety  of 
control  irksome  and  have  generally  advocated  federal  control  of 
insurance.  Although  something  would  be  gained,  it  cannot  be 
said  that  there  is  any  great  need  of  federal  control  of  life  insur- 
ance, not  to  mention  the  constitutional  difficulties,  because  it  is 
not  absolutely  necessary,  as  in  transport  or  fire  insurance,  that 
one  life  company  do  business  in  many  states,  and  the  people  of 
each  state  should  have  the  power  to  say  what  kind  of  insurance 
institutions  they  desire  to  have. 

An  enumeration  of  the  requirements  in  the  state  of  New  York 
will  illustrate  the  nature  of  state  regulation :  A  certificate  of 
authorization  must  be  obtained  from  the  Superintendent  of  In- 
surance and  a  deposit  of  securities  must  be  made.  A  minimum 
capital  stock  is  prescribed  and  regulations  are  made  concerning 

1  Consult  the  article  by  M.  M.  Dawson  in  Bliss,  Encyclopedia  of  Social  Reform, 
new  ed.,  p.  637. 


INSURANCE  587 

the  investment  of  stock  and  surplus.  There  are  also  provisions 
relating  to  standards  of  solvency,  reinsurance,  limitation  of  risks, 
admission  of  foreign  companies,  examination  of  accounts,  and 
annual  reports.  The  policy  must  contain  the  entire  contract, 
and  the  statements  are  to  be  taken  as  representations  and  not 
warranties.  No  misleading  estimates  and  deceptive  statements 
are  to  be  issued  for  the  purpose  of  getting  business.  Life  insur- 
ance companies  are  to  do  either  a  participating  or  non-partici- 
pating business,  and  in  the  former  case  the  surplus  must  be  an- 
nually apportioned  and  paid  to  each  policy.  There  are  further 
provisions  regarding  the  valuation  of  policies,  surrender  values, 
discrimination,  election  of  directors,  limitation  of  the  amount  of 
new  business  each  year,  limitations  as  to  expenses  and  salaries  of 
officers,  and  standard  forms  of  policies  are  prescribed  for  both  life 
and  fire  insurance. 

Social  Insurance 

Social  Insurance  Defined.  —  Social  insurance  refers  to  those 
insurance  or  quasi-insurance  institutions  which  are  organized 
by  the  state  to  alleviate  the  distress  which  is  likely  to  fall  upon 
the  poorer  classes  as  a  result  of  accident,  sickness,  invalidity, 
old  age,  unemployment,  and  the  premature  death  of  the  chief 
wage  earner  of  the  family.  All  insurance  is  obviously  social 
in  the  sense  that  it  implies  cooperation  on  the  part  of  many 
persons  and  is  subject  to  extensive  state  regulation,  but  what 
is  called  social  insurance  implies  the  activity  of  the  state  far  be- 
yond mere  regulation.  It  is  true  that  private  activity  has  done 
much  in  the  direction  of  workingmen's  insurance,  but  it  is  be- 
cause these  efforts  have  proved  inadequate  that  the  movement 
for  social  insurance  has  gathered  force.  It  is  to  be  distinguished 
from  poor  relief  in  that  it  recognizes  that  the  normally  thrifty 
wage  earner  cannot  purchase  adequate  life  and  accident  insur- 
ance from  private  commercial  companies  and  that  the  respon- 
sibility rests  on  society  to  provide  that  which  it  is  impossible  for 
the  individual  to  provide.  It  endeavors  by  insurance  methods 
to  provide  in  advance  for  the  coming  of  the  evil  day,  so  that  the 


588  OUTLINES  OF   ECONOMICS 

benefits  paid  will  be  received,  not  as  a  matter  of  charity,  but 
as  a  matter  of  right. 

Compensation   for   Industrial   Accidents.  —  In    the    United 
States  social  insurance  has  begun  its  development  in  connection 
with  the  problem  of  industrial  accidents.     Under  the  common 
law,  the  employer  is  not  responsible  to  an  employee  injured 
while  at  work  if  a  reasonably  safe  place  to  work  has  been  fur- 
nished.    Even  if  the  employer  is  at  fault,  there  is  no  redress  if 
there  has  been  contributory  negligence  on  the  part  of  the  em- 
ployee or  one  of  his  fellow  servants  or  if  the  accident  happens 
without  negligence  that  can  be  traced  to  any  particular  person. 
This  law  of  negligence  has  generally  been  modified  by  legis- 
lation designed  to  increase  the  responsibility  of  the  employer,  as, 
for  example,  by  the  restriction  or  elimination  of  the  fellow  ser- 
vant doctrine.1    While  employees  have  sometimes  been  able  to 
secure  damages  amounting  to  small  fortunes,  the  general  result 
of  this  legal  system  is  that  in  the  vast  majority  of  cases  only 
small  damages  or  none  at  all  are  secured,  or,  if  secured,  they  are 
in  large  part  offset  by  the  cost  of  litigation.     The  liability 
)f  the  employer,  however,  is  a  serious  matter  to  him,  and  an  ex- 
pensive system  of  employers'  liability  insurance  has  grown  up. 
The  more  severe  the  modifications  in  the  law  of  negligence  be- 
(ome,  the  higher  are  the  rates  imposed  by  the  liability  com- 
panies.    Such  is  the  expense  of  conducting  this  business  that 
i  i  is  safe  to  say  that  less  than  one  half  of  the  money  paid  for  em- 
ployers' liability  insurance  premiums  ever  reaches  the  injured 
employees  in  damages.     While  labor  leaders  were  drafting  bills 
designed  to  increase  still  further  the  liability  of  employers, 
attention  was  turned  to  European  practice,  where  the  view 
had  come  to  prevail  that  it  is  useless   to   try   to  locate   the 
responsibility  for  accidents,  except  for  purposes  of  preventing 
them  in  the  future,  and  that  if  a  workman  is  injured  in  the 
course  of  his  employment,  he  should  be  promptly  assisted,  even 
if  he  had  been  negligent.     Accidents  were  looked  upon  as  a 
trade  risk  against  which  the  workingman  should  be  adequately 
Insured. 

1  See  Chapter  xn'ii. 


INSURANCE  589 

The  result  was  that  in  the  years  following  1910  a  wave  of  work- 
men's compensation  legislation  swept  over  our  northern  and 
western  states.  By  the  end  of  1914  over  one  half  of  our  states 
had  enacted  compensation  for  accident  laws.  The  federal 
government  had  in  1908  established  a  system  of  compensation 
for  industrial  accidents  for  the  majority  of  its  industrial  em- 
ployees. During  the  first  five  years  of  its  operation  $1,804,000 
was  paid  out  as  compensation,  nearly  one  half  of  which  was  paid 
to  employees  of  the  Isthmian  Canal  Commission.  The  law 
did  not  abolish  the  criterion  of  negligence,  as  according  to  its 
terms  accidents  resulting  from  the  misconduct  or  negligence 
of  the  injured  person  are  not  compensated.  The  amount  of 
compensation  is  the  injured  workman's  wages  during  disability, 
not  exceeding  one  year,  or  in  fatal  cases,  an  amount  equal  to  one 
year's  wages.  In  other  respects  also  the  law  does  not  conform 
to  an  ideal  compensation  law  and  efforts  have  been  made  tc 
amend  it.1 

The  provisions  of  the  various  state  laws  differ  greatly  in  de- 
tail, but  it  may  be  said  that  in  general  they  provide  for  definite 
payments  to  injured  workmen  in  hazardous  employments,  prac- 
tically regardless  of  negligence  and  almost  universally  at  the 
expense  of  the  employer.  In  some  states  the  law  is  compul- 
sory, that  is,  the  employer  engaged  in  the  industries  covered 
must  pay  the  compensation  specified  and  must  insure  himself 
against  the  liability.  In  other  states  the  law  is  nominally  op- 
tional, the  employer  and  employee  being  free  to  remain  under 
the  old  law  of  negligence,  but  an  inducement  is  given  to  them  to 
choose  the  new  compensation  method  by  providing  that  if  either 
.Iocs  not  accept  it,  he  is  put  to  certain  disadvantages  under  the 
law  of  negligence.  The  purpose  of  this  roundabout  method  (not 
always  successful)  of  securing  compliance  is  to  overcome  the 
difficulty  that  under  our  constitutional  guarantees  of  freedom 
a  direct  compulsion  might  not  be  sanctioned  by  our  courts, 
while  the  modification  of  the  law  of  negligence  is  well  established 
by  precedent. 

The  following  are  the  standards  (abridged)  recommended  by 

1  Bulletin  of  the  Bureau  of  Labor  Statistics,  No.  155,  p.  77. 


590  OUTLINES  OF  ECONOMICS 

American  Association   for  Labor   Legislation  for  workmen's 
compensation  laws : 1 

i.  As  to  the  scale  of  compensation:  Medical  attendance 
should  be  furnished.  No  compensation  should  be  paid  for  a 
definite  period  at  the  beginning  of  disability,  the  period  being 
not  less  than  three  nor  more  than  seven  days.  The  disabled 
workman  should  receive  during  total  disability  66|  per  cent 
of  wages,  not  to  exceed  $20.00  a  week  and  not  less  than  $5.00. 
In  case  of  partial  disability  the  compensation  is  based  on  loss 
of  earning  power.  In  case  of  death,  the  employer  should  be 
required  to  pay  funeral  expenses,  and  the  widow,  if  living  with 
the  decedent  at  the  time  of  his  death,  or  if  dependent,  should  be 
granted  35  per  cent  of  his  wages  until  her  death  or  re-marriage, 
with  a  lump  sum  on  re-marriage  equal  to  two  years'  compensa- 
tion.    Compensation  may  also  be  given  to  other  dependents. 

2.  The  general  argument  for  compensation  applies  to  all 
employments,  but  practical  considerations  may  justify  the  tem- 
porary exclusion  of  farm  labor,  domestic  servants  (except  in 
connection  with  hotels  and  restaurants)  and  casual  employ- 
ment not  carried  on  for  the  profit  of  the  employer. 

3.  Compensation  should  be  provided  for  all  personal  injuries 
in  the  course  of  employment,  and  death  resulting  therefrom  in 
six  years,  but  no  compensation  should  be  allowed  where  the 
injury  is  occasioned  by  the  wilful  intention  of  the  employee 
to  bring  about  the  injury  or  death  of  himself  or  another.  The 
act  should  embrace  occupational  diseases  which,  when  con- 
tracted in  the  course  of  employment,  should  be  considered 
personal  injuries  for  which  compensation  shall  be  payable. 

4.  Compensation  should  be  the  exclusive  remedy;  that  is, 
the  workman  should  not  be  given  the  option  of  bringing  suit 
under  the  law  of  negligence. 

5.  Employers  should  be  required  to  insure  their  compensation 
liability.  Employers  may  maintain  their  own  insurance  fund 
under  certain  conditions,  insure  in  a  mutual  association,  in  a  state 
insurance  fund,  or  in  a  private  stock  company. 

6.  An  accident  board  should  be  maintained  by  the  state, 

1  American  Labor  Legislation  Review,  vol.  iv,  p.  58.S. 


INSURANCE  59I 

the  members  of  which  should  devote  their  entire  time  to  the 
administration  of  the  compensation  law. 

7.  Provision  should  be  made  for  the  settlement  of  compen- 
sation claims  either  by  agreement  subject  to  the  approval  of  the 
accident  board,  or  if  no  agreement  is  reached,  by  arbitration, 
with  an  appeal  to  the  accident  board.  Appeals  from  the  decrees 
of  the  accident  board  should  be  allowed  only  on  questions  of  law. 

8.  Provision  should  be  made  for  full  and  accurate  reports  of 
all  industrial  accidents. 

Occupational  diseases  are  not  included  by  the  compensation 
laws  of  the  several  states,  although  the  Supreme  Court  of  Massa- 
chusetts has  construed  such  diseases  to  be  injuries  entitling  the 
employee  to  compensation.  In  Michigan,  however,  the  con- 
trary view  has  been  taken. 

Sickness  Insurance.  —  Compulsory  sickness  insurance  has 
been  introduced  in  about  one  half  of  the  large  countries  of 
Europe  and  voluntary  subsidized  sickness  insurance  in  others, 
but  we  have  so  far  left  practically  everything  in  this  direction 
to  private  effort,  although  there  are  state  miners'  hospitals  in 
five  states  and  the  federal  government  conducts  a  hospital 
service  for  seamen.  Many  students  of  the  subject  believe  that 
sickness  insurance  will  never  be  made  effective  unless  it  is  made 
compulsory.  It  is  significant  that  Great  Britain,  where  the  tradi- 
tions, as  in  the  United  States,  are  against  compulsion,  made 
sickness  insurance  compulsory  by  the  act  of  191 1.  The  major- 
ity of  workers,  by  virtue  of  being  employed,  are  assured  certain 
benefits  in  case  of  illness,  the  cost  of  the  insurance  being  met 
partly  by  the  government,  partly  by  the  employer,  and  partly  by 
deduction  from  the  employees'  wages.  In  Germany,  where  a 
system  of  compulsory  sickness  insurance  was  established  as  early 
as  1883,  one  third  of  the  cost  is  borne  by  the  employers  and  two 
thirds  by  the  employees.  The  sickness  insurance  benefits  in 
that  country  cover  also  the  care  in  whole  or  in  part  for  the  first 
thirteen  weeks  of  those  injured  as  the  result  of  industrial  acci- 
dents, after  which  time  the  accident  benefits  are  paid  wholly  from 
accident  insurance  funds,  and  include  maternity  benefits,  fu- 
neral benefits,  and  sometimes  sick  benefits  for  the  members  of  the 


592  OUTLINES  OF   ECONOMICS 

family  other  than  the  insured.  Maternity  benefits  were  added 
in  England  by  an  amendment  in  1913.  We  have  need  for  simi- 
lar laws  in  this  country  and  the  framing  of  such  laws  may  be 
looked  upon  as  the  next  step  in  social  insurance  here. 

Old  Age  Insurance.  —  We  are  familiar  in  the  United  States 
with  a  pension  system  growing  out  of  past  wars  and  with  local 
pensions  for  firemen  and  policemen.  Other  countries  have 
provided  in  a  much  more  general  way  by  pensions,  subsidized 
voluntary  insurance,  or  by  compulsory  insurance  for  the  relief  of 
persons  incapacitated  by  old  age.  Invalidity  and  old  age  insur- 
ance is  one  of  the  three  great  branches  of  the  German  insurance 
system.  It  covers  the  great  majority  of  the  wage  earners  of 
both  sexes.  There  are  contributions  in  equal  amounts  by  the 
insured  workmen  and  their  employers  and  a  yearly  addition  is 
made  to  each  pension  by  the  government.  The  English  law  of 
1908,  on  the  other  hand,  provides  for  a  straight  pension  to  per- 
sons 70  years  of  age  or  over  whose  incomes  are  below  $153  a 
year  and  who  have  not  certain  disqualifications  mentioned  in  the 
act.  The  amount  paid  varies  from  24  cents  to  $1.20  a  week. 
The  British  system  resembles  poor  relief  more  closely  than  insur- 
ance. For  years  an  attempt  has  been  made  to  induce  the  United 
States  government  to  adopt  an  old  age  pensions  system  for  its 
employees,  but  there  has  been  radical  difference  of  opinion  as  to 
whether  such  a  system  should  be  with  or  without  contributions 
by  employees.  In  this,  as  in  the  more  general  problem,  a  non- 
contributory  pension  may  be  the  more  advisable  at  the  start, 
but  a  contributory  old  age  insurance  system  is  doubtless  more 
desirable  as  permitting  of  more  liberal  incomes  and  as  en- 
couraging thrift. 

Unemployment  Insurance  —  The  solution  of  the  problem 
of  unemployment  involves  much  more  than  insurance.  The 
progress  of  industry  should  be  made  less  irregular  and  men  and 
opportunities  for  work  should  be  brought  together  more  readily. 
Attention  is  being  turned  at  present  in  the  United  States  to  the 
establishment  of  a  national  system  of  labor  exchanges.  It  is 
not  to  be  expected,  however,  that  unemployment  can  be  elimi- 
nated.    It  is  a  misfortune  which  should  be  provided  against  by 


INSURANCE  593 

insurance.  Many  European  cities  have  made  experiments  in 
this  field  which  have  left  much  doubt  as  to  the  practicability 
of  insurance  as  a  general  remedy  for  the  evil  of  unemployment. 
But  the  British  National  Insurance  Act  of  191 1  has  instituted  a 
great  experiment  which  is  tending  to  remove  this  doubt.  By 
that  act  persons  engaged  in  building,  construction  of  railroads, 
docks,  or  canals,  shipbuilding,  iron-founding,  construction  of 
vehicles,  and  saw-milling  are  entitled  to  receive  unemployment 
benefits.  About  a  quarter  of  a  million  of  persons  are  covered 
by  the  act.  The  cost  of  this  insurance  is  met  by  contributions 
from  employers  and  employees  and  partly,  from  appropriations 
by  Parliament. 

Life  Insurance  for  Workingmen.  —  Our  private  life  insurance 
companies  are  selling  a  good  many  policies  which  are  pay- 
able, not  as  lump  sums,  but  in  installments  or  annuities,  to  the 
survivors  of  the  insured.  Wage  earners  cannot  often  afford  to 
purchase  such  policies,  but  the  same  object  is  to  some  extent 
attained  by  widows'  and  orphans'  pensions.  Beginning  with 
191 2  such  pensions  have  been  made  a  part  of  the  German  in- 
surance system.  In  the  United  States  many  state  laws  have 
recently  been  enacted  providing  for  pensions  to  mothers  in  need 
of  relief.  While  these  American  acts  are  to  be  viewed  as  a  form 
of  poor  relief,  they  are  significant  as  possible  forerunners  of  a 
comprehensive  system  of  workingmen's  life  insurance. 

Objections  to  Social  Insurance.  —  Aside  from  questions  of 
constitutional  law,  social  insurance  is  met  with  the  following 
difficulties :  (1)  It  implies  a  considerable  addition  to  the  wages 
bill  and  it  has  been  urged  that  it  is  unfair  to  place  this  burden 
on  the  employers  of  one  state  unless  similar  burdens  are  placed 
on  employers  of  other  states.  (2)  It  is  contrary  to  the  eco- 
nomic philosophy  of  those  who  wish  to  see  state  activity  reduced 
to  a  minimum.  (3)  It  has  been  charged  that  social  insurance 
discourages  thrift  and  that  it  leads  to  demoralization  because  it 
encourages  malingering  and  staying  at  home  for  trivial  ailments. 
Cases  are  cited  in  which  a  maternity  benefit  was  spent  on  liquor 
by  the  husband,  and  one  man  is  said  to  have  spent  the  maternity 
benefit  in  the  purchase  of  a  graphophone.     It  should  be  noted. 


594  OUTLINES  OF   ECONOMICS 

however,  that  all  insurance  is  subject  to  abuse.  Who  would 
question  the  beneficence  of  fire  insurance  because  it  leads  in 
some  cases  to  incendiarism?  Fire  insurance  companies  do  a 
good  deal  in  the  way  of  fire  prevention.  Similarly,  not  the 
least  important  aspect  of  social  insurance  is  its  relation  to  the 
conservation  of  the  national  health.  The  employers'  associa- 
tions in  Germany  organized  for  accident  compensation  have 
done  much  for  accident  prevention,  and  a  system  of  sickness 
insurance  gives  timely  medical  and  adequate  care  to  many  who 
now  waste  their  money  on  patent  medicines. 

QUESTIONS 

i.  Define  insurance. 

2.  What  is  a  mortality  table? 

3.  How  would  you  find  the  premium  for  insuring  a  group  of  persons  for 
one  year  for  $1000  each? 

4.  Distinguish  between  reserve  and  surplus. 

5.  What  is  a  "pure"  endowment  policy? 

6.  What  are  the  advantages  and  disadvantages  of  assessment  insurance  ? 

7.  What  has  been  New  Zealand's  experience  with  State  insurance  ? 

8.  What  is  meant  by  the  "moral  hazard"? 

9.  What  are  tontine  policies? 

10.  Why  is  the  "fellow-servant  doctrine"  not  suited  to  modern  con- 
ditions ? 

11.  Discuss  the  possible  effects  of  social  insurance  on  wages. 

12.  Are  old-age  pensions  a  form  of  insurance? 

REFERENCES 

Alexander,  William.     The  Life  Insurance  Company. 

American  Labor  Legislation  Review:  "Social  Insurance,"  June,  1913; 
"  Sickness  Insurance,"  March,  1914;   "  Unemployment,"  May,  1914. 

Annals  of  the  American  Academy  of  Political  and  Social  Science,  Vol.  xxvi. 

Dawson,  M.  M.  The  Elements  of  Life  Insurance;  The  Business  of  Life 
Insurance. 

Dawson,  W.  H.    Social  Insurance  in  Germany. 

Foerster,  R.  F.  "The  British  National  Insurance  Act,"  Quarterly  Jour- 
nal of  Economics,  Vol.  xxvi,  p.  275. 

Frankel,  L.  K.  and  Dawson,  M.  M.    Social  Insurance  in  Germany. 

Fricke,  W.  A.  (compiler).    Insurance  —  A  Text-book. 

Gephart,  W.  F.    Insurance  and  the  State;  Principles  of  Insurance  (Life). 

Gibbon,  I.  G.     Unemployment  Insurance,  Chap.  viii. 


INSURANCE  595 

Gow,  William.    Marine  Insurance. 

Hcebner,  Solomon.    Property  Insurance;  Life  Insurance. 

Jack,  A.  F.    An  Introduction  to  the  History  of  Life  Assurance. 

Kitchen,  F.  H.     The  Principles  and  Finance  of  Fire  Insurance. 

Massachusetts  Commission  on  Old  Age  Pensions,  Annuities,  and  Insurance. 

Report,  iqio. 
Moir,  Henry.     Life  Assurance  Primer. 

New  York  Insurance  Investigating  Committee.     Report,  1905  (6  vols.). 
Rubinow,  I.  M.    Social  Insurance. 
Seager,  H.  R.    Social  Insurance. 
The  Insurance  Year  Book,  Annual  (2  vols.) 
United  States  Bureau  of  Labor  Statistics.    Bulletin,  Nos.  101,  102,  103,  107 

109,  126,  and  155. 
United  States  Commissioner  of  Labor.     Twenty-fourth  Annual  Report. 
Walford,  Cornelius.     The  Insurance  Guide  and  Handbook. 
Wisconsin  Insurance  Investigating  Committee.     Report,  1906. 
Yale  Readings  on  Insurance  (2  vols.) 
Zartman,  L.  W.     The  Investments  of  Life  Insurance  Companies. 


CHAPTER  XXDt 
AGRICULTURAL   PROBLEMS 

The  socialistic  ideal  of  a  highly  centralized  and  delicately 
coordinated  industrial  system,  discussed  in  the  following  chap- 
ter, is  confronted  with  a  sharp  contrast  in  the  agricultural  in- 
dustry as  it  exists  to-day.  Even  in  the  most  advanced  coun- 
tries, agriculture  is  still  strikingly  decentralized,  and  furnishes 
at  once  the  best  illustration  and  the  most  fertile  source  of 
economic  individualism.  Even  in  this  country,  where  the 
movement  of  industrial  consolidation  has  proceeded  with  un- 
usual rapidity,  agriculture  has  never  been,  and  shows  little 
tendency  to  become,  a  large-scale  industry.  The  principal 
statistical  evidence  bearing  upon  this  aspect  of  American  agri- 
culture is  presented  in  Table  I,  on  the  following  page. 

Size  of  Farms.  —  So  magnificent  was  the  public  domain  of 
the  United  States  that  for  many  generations  the  number  of 
farms  increased  more  rapidly  than  the  population  and  much 
more  rapidly  than  the  rural  population.  Between  1850  and 
1910,  for  instance,  the  number  of  farms  increased  more  rapidly 
than  the  population  in  four  of  the  six  decades.  But  such  a 
movement  could  not  continue  indefinitely,  and  in  recent  years 
the  relative  number  of  farms  has  slightly  fallen  off.  Even  to- 
day, however,  as  shown  in  the  last  column  of  Table  I,  there  is  a 
larger  acreage  of  improved  farm  land  per  capita  than  there  was 
in  1850,  and  despite  the  rapid  increase  of  population  between 
1900  and  1 9 10,  the  increase  in  the  amount  of  improved  farm 
land  almost  kept  pace. 

This  steady  increase  in  the  number  of  farms  and  farmers  could 
only  have  been  maintained  by  a  general  diminution  in  the  aver- 
age size  of  the  farm.  From  1850  to  1910  the  average  number 
of  acres  per  farm  decreased  from  203  to  138,  while  the  acreage 

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598  OUTLINES  OF   ECONOMICS 

of  improved  land  per  farm  has  remained  nearly  constant. 
Since  1880  we  have  had  detailed  statistics  for  farms  of  different 
sizes.  Farms  of  all  sizes  have  been  increasing,  but  the  in- 
crease has  been  greatest  for  farms  under  50  acres  in  size,  the 
relative  importance  of  which  has  increased  steadily  since  1880. 
The  relative  importance  of  farms  over  50  acres  in  size  has 
decreased. 

Broad  statements  of  this  kind  cover  a  multitude  of  different 
movements  and  tendencies.  Between  1900  and  1910,  for  in- 
stance, farms  under  50  acres  and  from  175  to  1000  acres  increased 
more  rapidly  than  the  total;  whereas  farms  from  50  to  175 
acres,  and  those  over  1000  acres  in  extent,  increased  less  rapidly 
than  the  total.  In  the  North,  between  1900  and  1910,  farms 
between  20  and  100  acres  in  size  decreased  both  absolutely  and 
relatively ;  all  others,  including  farms  over  1000  acres,  gained 
in  relative  importance. 

In  the  South,  farms  smaller  than  100  acres  increased  while 
those  over  100  acres  in  size  diminished  in  relative  importance. 
In  the  West  the  movement  was  substantially  the  same  as  in  the 
South :  farms  under  100  acres  in  size  increased  while  all  those 
over  100  acres  in  size  lost  ground,  comparatively  speaking, 
except  the  class  of  farms  containing  from  175  to  449  acres, 
which  showed  a  small  relative  gain.  In  the  North,  particu- 
larly in  New  England,  there  seems  to  be  a  real  increase  in  the 
number  and  importance  of  the  large  farms,  those  which  in  cer- 
tain sections  would  be  called  "  gentlemen's  farms  "  ;  but  this 
is  more  than  counterbalanced  by  the  partition  of  plantations  of 
the  South  and  of  the  cattle  ranges  and  bonanza  farms  in  the 
West. 

Although  the  average  farm  decreased  in  size  between  1900 
and  1910,  there  was  a  striking  increase  in  the  value  of  the  aver- 
age farm  and  its  equipment.  In  the  last  half  of  the  nineteenth 
century  no  tendency  towards  the  increase  in  capital  value  of 
the  farm  unit  had  appeared.  The  value  of  the  total  property 
and  equipment  of  the  average  farm  was  actually  lower  in  1900 
than  in  i860;  and  the  increase  in  the  items  of  implements  and 
machinery  was  quite  in  keeping  with  the  rapid  growth  in  wealth 


AGRICULTURAL   PROBLEMS  599 

and  income  in  the  United  States,  particularly  among  agricul- 
tural laborers  and  farm  population.  But  between  1900  and 
1 9 10  the  situation  was,  in  appearance  at  least,  transformed. 
As  one  commentator  has  aptly  said,  the  selling  price  of  farm 
property  increased  by  a  larger  amount  in  the  first  decade  of  the 
twentieth  century  than  it  did  in  the  entire  period  between  the 
landing  of  Columbus  and  the  close  of  the  nineteenth  century. 
The  average  value  of  all  farm  property  per  farm,  as  shown  by 
Table  I,  rose  from  $3563  in  1900  to  $6444  in  1910.  The  in- 
crease was  greatest  in  the  value  of  the  land  itself.  In  this 
decade  the  average  value  per  farm  of  all  farm  property  in- 
creased 80.9  per  cent;  that  of  land  alone,  96.7  per  cent;  farm 
buildings,  60.3  per  cent;  implements  and  machinery,  51.9  per 
cent ;   farm  animals,  including  poultry  and  bees,  44.4  per  cent. 

The  full  significance  of  this  striking  change  is  difficult  to 
ascertain.  In  many  respects  is  it  more  apparent  than  real  and 
reflects  merely  the  depreciation  in  the  general  purchasing  power 
of  the  monetary  unit.  Thus,  the  average  value  of  farm  equip- 
ment per  farm  increased  in  a  decade  from  $667  to  $973,  only 
45.9  per  cent,  hardly  more  than  the  general  increase  in  prices 
throughout  the  country  and  probably  no  more  than  the  aver- 
age income  or  ability  of  the  typical  farmer.  So  far  as  equip- 
ment is  concerned  it  is  probably  no  more  difficult  for  the  aver- 
age farmer  to  secure  the  required  amount  of  equipment  today 
than  it  was  twenty  years  ago.  But  the  total  value  of  farm 
land  has  increased  more  than  100  per  cent,  and  the  value  of  the 
land  in  the  average  farm  has  increased  nearly  100  per  cent. 
The  movement  is  real  and  exceedingly  significant  so  far  as 
land  values  are  concerned.  Prices  of  farm  products  have  in- 
creased more  rapidly  than  most  other  prices.  This  has  re- 
flected itself  in  a  rise  in  the  value  of  farm  land  which  is  far 
greater  than  the  rise  in  the  general  price  level.  It  has  become 
in  many  sections  far  more  difficult  than  it  used  to  be  for  the 
young  farmer  to  secure  a  farm  of  his  own,  and  in  those  districts 
tenancy  has  increased  rapidly,  while  in  many  of  them  the  popu- 
lation has  actually  declined. 

Technically  speaking,  therefore,  there  appears  no  significant 


6oo  OUTLINES  OF   ECONOMICS 

increase  in  the  size  of  the  unit  of  agricultural  industry.  The 
farm  unit  is  not  growing  in  the  physical  or  material  sense  in 
which  the  factory  may  be  said  to  be  growing.  There  is  no 
consolidation  or  concentration  such  as  we  find  in  the  manufac- 
turing industries.  But  the  amount  of  capital  represented  by  the 
farm  unit  has  increased  strikingly  in  the  last  few  years  and 
probably  much  more  rapidly  than  the  average  wealth  or  in- 
come of  the  farm  population.1 

So  much  for  the  size  of  the  farm  as  it  is ;  the  next  question 
concerns  the  size  of  the  farm  as  it  should  be.  Would  the  pros- 
perity cf  the  agricultural  classes  and  the  general  welfare  be  in- 
creased by  expanding  or  reducing  the  farm  unit,  by  more  or  less 
intensive  farming? 

Obviously  no  simple  answer  can  be  given  to  this  question. 
The  value  of  the  land  or  the  rent  it  will  bring  is  perhaps  the 
most  important  factor :  high  rental  value  indicates  that  the 
margin  of  cultivation  has  been  forced  to  a  comparatively  low 
point,  and  makes  it  both  necessary  and  profitable  to  work  the 
land  intensively,  for  the  same  reason  that  the  owner  of  a  very 
valuable  manufacturing  plant  is  inclined  to  run  it  night  and 
day,  if  possible,  in  order  to  reduce  that  part  of  the  cost  of  pro- 
duction which  represents  fixed  charges  or  interest  on  the  capital 
that  is  sunk  in  the  enterprise.  In  addition  to  the  factor  of  rent, 
the  amount  of  capital  that  he  can  command,  the  kind  of  farm- 
ing in  which  he  is  most  skilled,  the  character  of  the  labor  he  can 
secure,  the  proximity  of  markets,  and  the  adequacy  of  trans- 
portation facilities,  all  must  be  taken  into  account  by  the  in- 
dividual farmer  in  determining  how  large  a  farm  he  will  attempt 
to  manage  and  how  intensively  he  will  farm  it. 

Speaking  generally,  however,  two  powerful  but  counteracting 
forces  can  be  detected  in  the  agricultural  industry,  which  pre- 
vent the  industry  from  becoming  either  predominantly  inten- 
sive or  predominantly  extensive.  On  the  one  hand,  machinery 
can  be  employed  most  advantageously  on  a  comparatively  large 

1  "  In  recent  years  the  value  of  farm  lands  has  been  increasing  at  the  rate  of  about 
5  per  cent  a  year,  or  approximately  $2  per  acre  per  year."  Monthly  Crop  Report, 
vol.  ii,  No.  4  (April  15,  1916). 


AGRICULTURAL  PROBLEMS  6oi 

farm,  and,  other  things  being  equal,  the  use  of  labor-saving 
machinery  is  desirable.  On  the  other  hand,  the  importance  of 
labor  is  greater,  and  the  importance  of  the  manager  or  entre- 
preneur is  less,  in  agriculture  than  in  manufactures ;  and  on 
this  account  the  stimulus  given  to  the  individual  laborer  by  the 
sense  of  proprietorship  is  a  far  more  potent  factor  in  agriculture 
than  in  other  industries.  Large  factories  controlled  by  one 
entrepreneur  employing  hundreds  of  dependent  workmen  have 
proved  economically  superior  in  the  manufacturing  industry, 
because  of  the  possibility  of  supervising  the  labor,  checking  and 
measuring  its  efficiency  automatically.  In  agriculture,  how- 
ever, technical  skill  remains  far  more  important  relatively  to 
those  commercial  or  financial  talents  which  distinguish  the 
successful  employer  than  in  any  other  great  division  of  pro- 
duction. 

This  question  is  primarily  one  of  private  profit,  which  the  in- 
dividual must  decide  for  himself,  but  the  legislator  and  the 
scientific  student  can  assist  the  farmer  by  helping  him  to  develop 
and  use  a  system  of  sound  farm  accounting,  and  in  keeping 
him  awake  to  those  changes  in  prices,  wages,  and  transportation 
charges  to  which  the  farm  organization  must  adjust  itself.  On 
the  whole,  however,  the  emphasis  is  wisely  placed  by  the  aver- 
age educator,  at  the  present  time,  upon  the  possibilities  and 
opportunities  of  more  intensive  farming.  In  the  past,  exten- 
sive farming  has  been,  and  justifiably  so,  the  rule  in  this  coun- 
try, and  the  force  of  inertia  is  all  directed  that  way.  But  the 
demands  of  the  future  will  be  in  the  opposite  direction.  As 
cities  multiply  and  the  market  approaches  the  farm,  intensive 
farming  will  be  forced  upon  the  people,  and  the  readier  we  are 
to  adapt  ourselves  to  this  change,  the  less  will  be  the  friction 
and  loss.  Moreover,  the  ability  to  earn  a  living  by  intensive 
farming  makes  it  easier  to  acquire  a  farm ;  and  we  are  strongly 
of  the  opinion,  as  will  appear  hereafter,  that  widely  diffused 
ownership  is  better  than  a  general  system  of  tenancy,  even 
where  land  values  are  high. 

Finally,  it  may  be  noted  that  practically  every  European  coun- 
try attempts  by  legislation  to  increase  the  number  of  small 


602  OUTLINES  OF  ECONOMICS 

holdings;  and  in  a  mixed  problem  of  this  kind,  which  is  as 
much  psychological  and  social  as  strictly  economic,  the  instincts 
of  the  majority  are  likely  to  have  a  sound  social  basis.  Even 
in  England,  where  comparatively  large  farming  has  had  the 
greatest  opportunity  and  the  most  favorable  environment,  the 
consensus  of  opinion  seems  to  favor  the  encouragement  of  small 
holdings.  English  authorities  maintain,  as  a  rule,  that  a  mixed 
system  of  large  and  small  farms  is  the  ideal  condition,  but  that 
at  present  the  emphasis  should  be  placed  on  intensive  farming. 
In  1889  a  (British)  select  committee  on  the  subject  recom- 
mended unanimously  that  "  the  extension  of  a  system  of  small 
holdings  is  a  matter  of  national  importance  "  ;  and  in  1892  Par- 
liament passed  the  Small  Holdings  Act  which  empowers  county 
councils  to  purchase  land  and  sell  or  lease  it  in  small  holdings. 
Purchasers  were  required  to  pay  one  fifth  of  the  price  on  taking 
possession,  and  the  remainder  in  fifty  years.  In  the  beginning 
the  act  does  not  appear  to  have  been  a  glowing  success,  and  by 
1903  only  62  small  holdings,  covering  248  acres,  had  been  sold, 
and  166  buildings,  covering  373  acres,  let.  In  1907,  however, 
a  new  Small  Holdings  and  Allotments  Act  was  passed,  special 
commissioners  were  authorized  to  ascertain  the  demand  for 
small  holdings  in  the  various  counties,  and  county  councils 
wrere  authorized  to  acquire  land  compulsorily.  Between  the 
passages  of  this  act  and  the  end  of  191 2  various  county  councils 
acquired  155,000  acres  of  land,  all  of  which,  except  two  per  cent, 
was  leased  to  small  holders.  In  191 2  there  were  292,720  small 
holdings  (one  to  fifty  acres)  in  England  and  Wales,  of  which 
9937,  or  about  3  per  cent,  had  been  provided  by  county  councils. 
While  there  is  a  marked  difference  of  opinion  in  Great  Britain 
on  the  subject,  the  weight  of  testimony  and  balance  of  opinion 
plainly  incline  towards  the  conclusions :  (1)  that  an  extension  of 
small  holdings  is  desirable  not  only  from  the  standpoint  of 
national  well-being  but  from  that  of  the  agricultural  laborer  as 
well ;  (2)  that  agricultural  laborers  who  employ  farming  methods 
suited  to  small  holdings  can  make  a  decent  living  without  an 
excessive  amount  of  toil,  in  proof  of  which  there  seems  to  be  a 
large  unsatisfied  demand  for  these  small  holdings ;  (3)  that  small 


AGRICULTURAL  PROBLEMS  603 

holdings  under  private  land  owners  are  likely  to  decline  rather 
than  increase  in  numbers,  owing  to  insecurity  of  tenure  and  high 
rents ;  (4)  and  that  in  consequence  the  intelligent  assistance  of 
the  government  is  needed  to  achieve  the  desired  results.1 

We  would  not  be  misunderstood.  A  universal  system  of  small 
holdings  would  be  good  for  no  country,  as  a  certain  number  of 
large  farmers,  assisted  by  abundant  capital,  are  needed  to  set 
the  pace  in  the  improvement  of  agricultural  methods.  And  in 
the  United  States,  it  is  hoped,  small  holdings  on  the  British 
scale  will  not  have  to  be  considered  for  many  generations.  But 
this  country  as  well  as  England  needs  to  cultivate  that  spirit 
which  has  made  Danish  agriculture,  in  spite  of  great  obstacles, 
such  a  marvelous  success ;  and  it  is  imperative  to  avoid,  if  we 
can,  the  growth  of  those  conditions  which  have  drawn  so  much 
of  the  best  blood  of  rural  England  to  the  cities.  Both  of  these 
objects,  we  believe,  will  be  measurably  advanced  by  the  encour- 
agement of  intensive  farming. 

Ownership  and  Tenancy.  —  The  essential  facts  bearing  upon 
the  subject  of  farm  ownership  and  tenure  are  summarized  in 
Table  II,  printed  on  the  following  page. 

Section  A  of  the  table  shows  that  share  tenancy  is  increasing 
in  the  United  States,  and  that  the  proportion  of  farms  operated 
by  their  owners  was  smaller  in  1910  than  in  any  earlier  census 
year.  Two  interpretations  of  this  phenomenon  have  been  ad- 
vanced. According  to  the  first,  which  is  based  partially  upon 
the  statistics  cited  in  Section  B  of  the  table,  the  growth  of 
tenancy  is  due  primarily  to  the  increasingly  rapid  rise  of  farm 
laborers  from  the  position  of  wage  earner  to  that  of  tenant. 
In  this  view,  accordingly,  the  increase  of  tenancy  is  encourag- 
ing. According  to  the  second  interpretation,  based  partially 
upon  the  facts  presented  in  Sections  C  and  E,  the  growth  of 
tenancy  is  not  an  encouraging  sign,  and  indicates  that  it  is 
becoming  more  and  more  difficult  to  acquire  ownership  of  land 
in  this  country.  The  statistics  of  ownership  under  C  prove 
that  there  is  a  steady  movement  from  tenancy  to  ownership  as 
farmers  grow  older.     More  than  70  per  cent  of  the  farmers 

1  Cf .  The  Report  of  the  Land  Enquiry  Committee,  vol.  i,  Part  ii,  Chap.  iii. 


604 


OUTLINES   OF   ECONOMICS 


TABLE   II 

Statistics  of  Farm  Ownership  and  Farm  Tenure  in  the  United 
States:  1880-1910 


1910 


1900 


1890 


Per  cent  of  farms  operated  by  owners  .  . 
Per  cent  of  farms  operated  by  cash  tenants 
Per  cent  of  farms  operated  by  share  tenants 

Per  cent  of  males  employed  in  agriculture  : 

Who  are  owners 

Who  are  tenants 

Who  are  laborers  and  others    .... 

Per  cent  of  persons  owning  farm  homes  : 

All  ages 

Under  25  years 

C  {       25  to  34  years 

35  to  44  years 

45  to  54  years 

55  years  and  over 


63.0 
13.0 
24.0 


D< 


Per  cent  of  owners  of  rented  farms  who  own  : 

1  farm 

2  farms 

3  and  under  5  farms 

5  and  under  10  farms 

10  and  under  20  farms 

20  farms  and  over 


Per  cent  of  farm  homes  owned  : 

Free 

Encumbered 

Encumbered,  all  ages  .  . 
Encumbered,  under  25  years 
Encumbered,  25  to  34  years 
Encumbered,  35  to  44  years 
Encumbered,  45  to  54  years 
Encumbered,  55  years  and  over 


66.4 
33-6 


64.7 

i3-i 
22.2 


42-3 
23.1 
34-6 

64.4 
27.8 

45-3 
64.4 

70.7 
81.4 

80.0 
11.4 
5-4 
2-3 
0.7 
0.2 


69.0 
31.0 
31.0 
29-3 
35-5 
366 
31.8 
24.6 


71.6 
10.0 
18.4 


42.0 
16.6 
41.4 


65-9 
32.6 
49.8 
64.0 

72.3 
82.2 


71.8 
28.2 
28.2 
21.9 

31-9 
3i-8 
30.2 
22.6 


The  statistics  opposite  B  are  in  the  nature  of  estimates,  a  small  number  of 
female  owners  and  tenants  being  included  under  "  laborers  and  others."  The  aggre- 
gate percentages  opposite  A  differ  from  those  opposite  C,  owing  to  the  fact  that  they 
were  collected  by  different  departments  of  the  census,  and  apply  to  slightly  different 
areas.  The  agricultural  statistics  published  in  the  reports  of  the  Thirteenth  Census 
are  not  so  detailed  as  those  published  in  the  reports  of  the  Twelfth  Census. 


AGRICULTURAL  PROBLEMS  605 

between  45  and  54  years  of  age,  but  only  45.3  per  cent  of  those 
between  25  and  34  years  of  age,  owned  the  farms  which  they 
operated  in  1900.  This  steady  advance  is  encouraging;  but 
the  comparison  of  the  figures  for  1900  and  1890  indicates  that 
the  rate  of  advance  is  declining.  Moreover,  the  statistics  pre- 
sented in  Section  E  show  that  the  proportion  of  owned  farms 
which  were  burdened  with  indebtedness  was,  for  every  age  group, 
larger  in  1900  than  in  1890,  and,  in  the  aggregate,  larger  in  1910 
than  in  1890. 

The  statistics  presented  in  Table  II  and  the  two  interpretations 
of  their  meaning  are  not,  in  reality,  inconsistent.  Tenancy  is 
more  frequent  in  the  South  Central  and  South  Atlantic  states 
than  in  other  sections  of  the  country,  and  more  prevalent  among 
colored  farmers  than  any  other  class.  Here,  evidently,  tenancy 
does  represent  an  advance.  The  negroes  who  are  tenants  today 
were  farm  laborers  a  few  years  ago  and  slaves  a  half  century 
back.  On  the  other  hand,  tenancy  is  also  prevalent  and  grow- 
ing in  the  richest  farming  district  of  the  country,  a  district  in 
which  farm  values  are  high  and  advancing  very  rapidly;  and 
in  this  district  —  the  North  Central  states  —  there  is  evidence 
of  a  close  though  not  perfect  correlation  between  farm  values 
and  tenancy.1 

There  is  no  cause  for  grave  alarm  concerning  farm  tenancy  in 
this  country.  Although  the  census  of  1900  revealed  one  land- 
lord who  owned  704  farms  worth  $4,545,230,  Section  D  of  Table 
II  shows  that  80  per  cent  of  the  landlords  owned  only  1  rented 
farm,  and  96.8  per  cent  less  than  5  rented  farms ;  while  the 
additional  fact  that  78.8  per  cent  of  the  landlords  lived  in  the 
same  county  in  which  their  farms  were  located  proves  that 
absentee  landlordism  has  not  developed  to  any  extent  in  this 
country.  But  we  cannot  regard  present  tendencies  with  all  the 
complacency  exhibited  by  some  writers.2  For  not  only  has  it 
been  shown  that  the  increase  of  tenancy  in  the  North  Central 
states  is  probably  due  to  the  increasing  difficulty  of  acquiring 

1  See  H.  C.  Taylor,  Agricultural  Economics,  pp.  224-250. 

2  See  Twelfth  Census,  Agriculture,  Part  I,  pp.  lxxvii-lxxxi ;  and  E.  L.  Bogart  in 
the  Journal  of  Political  Economy,  vol.  xvi,  pp.  201-21 1. 


606  OUTLINES   OF   ECONOMICS 

land  consequent  upon  advancing  land  values;  but  tenancy  is 
almost  certain  to  increase  as  land  values  advance,  unless  the 
American  farmer  learns  how  to  get  a  living  from  smaller  hold- 
ings. And  land  values  are  increasing  with  almost  startling 
rapidity.  In  the  four  years  1911-1915  the  value  of  improved 
farm  land  in  this  country  increased  over  25  per  cent.  When 
land  goes  to  $200  an  acre,  the  average  young  farmer  can  neither 
save  enough  nor  command  enough  credit  to  buy  a  farm  of  160 
acres  and  equip  it  properly.  We  shall  have  either  more  tenancy 
in  the  older  sections  of  the  country,  as  time  passes,  or  smaller 
farms  and  a  different  type  of  agriculture.  As  stated  above,  the 
latter  change  would  probably  do  more  good  than  harm  in  the 
end.  Our  only  fear  is  that  the  American  farmer  may  not  adjust 
himself  to  it  rapidly  enough. 

And  it  is  doubtful  whether  we  ought  to  derive  comfort  from  an  increase 
in  the  proportion  of  owners  —  as  shown  in  Section  B  of  Table  II  —  when 
this  increase  results  from  an  exodus  of  the  agricultural  population  to  the 
cities,  which  must  itself  be  regarded  with  grave  apprehension.  Some 
writers  explain  away  the  increase  of  tenancy  by  dividing  the  agricultural 
class  into  three  reservoirs,  —  owners,  tenants,  and  others  (presumably 
laborers) ,  —  and  assure  us  that  the  swelling  volume  of  the  middle  reservoir 
is  due  to  an  increasingly  rapid  flow  from  the  labor  reservoir  to  the  tenant 
reservoir,  rather  than  a  decreasingly  rapid  flow  from  the  tenant  reservoir  to 
the  reservoir  of  owners.  But  what  about  the  flow  from  the  labor  reservoir 
to  non-agricultural  occupations?  And  how  much  of  the  diminution  of 
ownership  in  trade  and  manufactures  should  be  charged  to  the  same  move- 
ment of  population  from  the  country  to  the  city?  It  is  a  condition,  not  a 
theory,  confronting  us,  and  when  we  start  to  explain  this  condition,  it  is 
not  permissible  to  halt  midway  in  the  explanation. 

Farm  Labor  and  Earnings.  —  It  is  not  difficult  to  understand 
the  "  exodus  from  the  farm  "  when  we  consider  the  demands 
which  farming  makes  on  the  industry  and  managerial  skill  of  the 
farmer,  the  lure  of  city  life,  and  the  relatively  small  amount  of 
cash  which  the  farmer  has  at  his  command.  The  labor  and 
drudgery  of  farm  life  are  steadily  being  lightened,  the  income 
of  the  farmer  has  risen  rapidly  in  late  years,  and  as  a  recent 
writer  tells  us,  "  it  is  probably  true  that  the  farming  population 
of  the  United  States,  consisting  as  it  does  of  more  than  thirty 


AGRICULTURAL   PROBLEMS  607 

million  people,  has  a  larger  average  income  per  family  than  any 
other  equally  homogeneous  group  of  individuals  of  anything 
like  the  same  size  anywhere  in  the  world."  But  when  taxes 
and  interest  on  indebtedness  are  paid  the  average  farm  family 
has  little  actual  cash  to  spend  on  amusements,  and  a  careful 
estimate  made  by  the  same  writer  for  the  year  1909  "  shows 
that  after  all  the  expenses  are  paid  the  average  family  has  $7  24 
of  net  earnings,  of  which  $322  was  earned  by  the  capital  in- 
vested in  the  farm,  and  $402  by  the  labor  of  the  farmer  and  his 
family.  These  $724  of  net  earnings  were  received  by  the  family 
in  the  following  manner :  $303  in  cash,  $35  as  fuel,  $125  as  rent, 
and  $261  as  food  furnished  by  the  farm."  l 

There  can  be  no  doubt,  however,  about  the  improvement  in 
the  conditions  and  wages  of  farm  labor.  The  movement  of 
farm  wages  since  the  Civil  War  is  described  statistically  in 
Table  III,  following.  From  this  it  appears  that  farm  wages 
were  higher  in  the  last  year  for  which  statistics  are  available 
than  ever  before,  if  we  properly  discount  the  inflated  currency 
in  which  wages  were  paid  in  1866,  1869,  and  1875.  Moreover, 
the  testimony  is  practically  unanimous  to  the  effect  that  the 
increased  use  of  farm  machinery  has  not  only  reduced  the  hours 
of  labor,  but  has  diversified  and  lightened  the  toil  of  the  farm 
hand.  Added  to  these  evidences  of  increasing  material  comfort 
is  the  reassuring  fact  that  the  farm  hand  retains,  in  a  large 
degree,  his  superior  social  position.  The  native  white  farm 
laborer  usually  eats  at  the  same  table  with  his  employer,  shares 
his  social  diversions,  and  in  general  mixes  in  the  same  social 
class  on  terms  of  approximate  equality. 

There  is  room,  however,  for  much  improvement.  The  hours 
of  labor  are  long  in  the  country,  —  10  in  winter,  12  in  summer, 
13  in  harvest  season,  according  to  our  latest  information,  — 
and,  except  on  a  very  small  number  of  farms,  there  are  two  or 
three  months  in  the  year  when  the  laborer  cannot  secure  full 
work.  "  The  able-bodied,  industrious  man  desirous  of  employ- 
ing his  full  vigor  continuously  finds  a  limitation  in  the  average 

1  E.  A.  Goldenweiser,  "The  Farmer's  Income,"  The  American  Economic  Review. 
vol.  vi,  pp.  46,  48. 


5o8 


OUTLINES   OF   ECONOMICS 


TABLE   III 

Wages  of  Farm  Labor  in  the  United  States  for  Specified  Years 

1866-1915 

(Wages  expressed  in  paper  currency  for  the  years  1866,  1869,  1875) 


Year 

Per  Month 

Per  Day 
at  Harvest 

Per  Day  Other 
Than  Harvest 

Without 
board 

With  board 

Without 
board 

With  board 

Without 
board 

With  board 

1915 

$30.15 

$21.26 

$1.92 

$1.56 

$1-47 

$1.13 

1914 

29.88 

21.05 

1.91 

I 

55 

145 

i-i3 

1911 

28.77 

20.18 

1.85 

1 

49 

I.42 

1.09 

1910 

27.50 

19.21 

I.82 

I 

45 

1.38 

1.06 

1902 

22.14 

16.40 

i-53 

I 

34 

i-i3 

.89 

1899 

20.23 

14.07 

i-37 

I 

12 

1. 01 

•77 

1898 
1895 

19.38 
17.69 

13-43 
12.02 

1.30 
1. 14 

I 

°5 
92 

.96 
.81 

.72 
.62 

1894 

17-74 

12.16 

i-i3 

93 

.81 

•63 

1893 
1892 

19.IO 
18.60 

13.29 
12.54 

1.24 
1.30 

I 
I 

03 
02 

.89 
.92 

•69 
.67 

1890 

18.33 

12.45 

1.30 

I 

02 

.92 

.68 

1888 

18.24 

12.36 

I-31 

I 

02 

.92 

.67 

1885 
1882 

17.97 
18.94 

12.34 
12.41 

1.40 
1.48 

I 
I 

10 
15 

.91 
•93 

.67 
.67 

1879 
187S 

16.42 
19.87 

IO.43 

12.72 

1.30 
1.70 

I 
I 

00 
35 

.81 
1.08 

■59 

.78 

1869 
1866 

25.92 
26.87 

16.5S 
17-45 

2.20 
2.20 

I 
I 

74 
74 

1.41 
1.49 

1.02 

1.08 

condition  of  farming.  Seed  time  and  harvest  make  busy  their 
respective  periods,  but  whenever  the  frost  of  winter  or  the 
drought  of  summer  suspend  the  activity  of  vegetation,  there 
will  be  an  interval  in  the  work  of  the  cultivator."  2 

1  See  Crop  Reporter,  vol.  xiv,  No.  3,  and  Monthly  Crop  Report,  vol.  ii,  No.  3. 
Broad  averages  are  particularly  unsatisfactory  in  dealing  with  the  wages  of  farm 
labor,  and  the  reader  should  regard  this  table  not  as  an  exact  exhibit  of  money 
wages,  but  as  a  compendious  method  of  describing  a  movement  the  details  of  which 
are  beyond  the  scope  of  this  treatise.  For  more  adequate  discussions,  see  Bulletin, 
No.  26,  Miscellaneous  Series,  and  Bureau  of  Statistics,  Bulletin  09,  U.  S.  Depart- 
ment of  Agriculture. 

2  J.  H.  Blodgett,  "  Wages  of  Farm  Labor  in  the  United  States,"  p.  25.  Bulletin, 
Vo.  26,  Miscellaneous  Series,  U.  S.  Department  of  Agriculture,  p.  25. 


AGRICULTURAL  PROBLEMS  609 

Furthermore,  the  best  evidence  obtainable  supports  the  con- 
clusion that  while  "  skilled  labor,  owing  to  its  contact  with  ma- 
chinery and  the  influence  of  education,  has  attained  increased 
efficiency,"  "  unskilled  and  irregular  labor  has  lost  much  of  its 
former  adaptability  and  value  to  the  farm."  l  Worst  of  all, 
there  is  rapidly  developing  a  class  of  migratory  or  casual  agri- 
cultural laborers  who  drift  from  city  to  country  and  back  again, 
who  have  no  ambition  to  establish  themselves  permanently 
upon  the  land,  and  yet  teach  the  farmer  to  rely  upon  their 
assistance,  and  debase  the  real  standard  of  living  of  the  laborer 
who  adopts  farming  as  a  serious  occupation,  and  looks  forward 
to  the  acquisition  some  day  of  a  farm  of  his  own. 

Farm  Indebtedness  and  Agricultural  Credit.  —  The  favorite 
instrument  by  which  land  ownership  is  achieved  in  this  coun- 
try is  the  farm  mortgage.  As  shown  above,  33.6  per  cent  of  the 
farms  in  this  country  were  mortgaged  in  1910,  and  this  propor- 
tion had  increased  from  28.2  per  cent  in  1890.  But  this  is  not 
in  itself  alarming.  The  ratio  of  mortgage  debt  to  farm  value 
was  only  27.3  per  cent  in  1910  as  against  35.5  per  cent  in  1890, 
and  the  owner's  average  unencumbered  equity  per  farm  in- 
creased from  $2200  in  1890  to  $4574  in  19 10.  Moreover,  the 
proportion  of  mortgaged  farms  in  the  latter  year  was  higher 
in  Iowa  and  Wisconsin  than  in  any  other  states,  although  agri- 
culture is  particularly  flourishing  in  these  states.  Statistics 
collected  in  1890  indicate  that  nearly  65  per  cent  of  mortgage 
indebtedness  of  farms  is  contracted  for  the  purpose  of  buying 
the  farms,  from  15  to  20  per  cent  for  stocking,  equipping,  drain- 
ing, and  improving  farms,  while  probably  not  more  than  5  or  6 
per  cent  represents  losses,  household  expenses,  and  "  unproduc- 
tive consumption."  The  farm  mortgage  accordingly  is  not 
necessarily  a  bad  thing.  It  is  "  a  mere  business  venture  "  and 
in  this  country  has  proved  a  successful  venture  in  a  surprisingly 
large  proportion  of  cases. 

If  farms  are  operated  more  efficiently  by  their  owners  than 
by  tenants  or  hired  managers,  it  is  obviously  desirable  to  get  the 
title  to  the  farm  into  the  hands  of  the  farm  operator  as  soon  as 

1  Final  Report  of  the  Industrial  Commission,  p.  92. 


610  OUTLINES   OF   ECONOMICS 

possible.  For  this  purpose  some  use  of  credit  is  usually  neces 
sary.  Credit  also  must  usually  be  used  to  secure  the  proper 
amount  of  farm  machinery,  stock,  and  other  equipment.  Agri- 
culture today  has  become  a  highly  capitalized  industry,  employ- 
ing in  this  country,  it  is  estimated,  about  twice  as  much  capital 
as  the  manufacturing  or  factory  industries.  And  the  indications 
are  that  the  average  farmer  at  present  cannot  secure,  or  at  least, 
does  not  employ,  enough  circulating  capital.  Studies  have  been 
made  of  the  earnings  of  farmers  classified  according  to  the  amount 
of  capital  employed  on  each  farm ;  and  these  indicate  that,  after 
due  deduction  for  interest  upon  all  capital  employed,  the  re- 
maining net  income  varies  directly  with  the  amount  of  capital 
employed,  until  the  latter  reaches  $25,000  or  $30,000.  The 
New  York  studies  indicate  that  farmers  working  with  less  than 
$5000  capital  earn  less  than  the  ordinary  farm  hand  in  the  same 
vicinity ;  and  that  in  the  districts  covered,  the  average  farmer 
cannot  earn  a  fair  return  for  his  labor  unless  he  has  the  use  ot 
from  $10,000  to  $20,000  worth  of  capital.  The  figures  in  ques- 
tion are  possibly  affected  by  the  probable  fact  that  it  is  the 
better  class  of  farmers  who  are  enabled  to  obtain  the  larger 
amount  of  loan  capital.  But  whether  this  be  the  fact  or  not, 
it  is  obviously  desirable  that  the  farmer  should  be  able  to  secure 
whatever  amount  of  capital  is  necessary,  at  the  lowest  practi- 
cable cost. 

At  the  present  time  credit  facilities  are  not  adequate  in  many 
rural  districts.  Recent  statistics  collected  by  the  federal  De- 
partment of  Agriculture,  for  instance,  show  that  the  average 
rate  for  interest  and  commissions  on  farm  mortgage  loans  ex- 
ceeds 7  per  cent  in  twenty-five  states,  and  rises  as  high  as  10 
per  cent  in  New  Mexico,  Montana,  and  Wyoming.  This  is  the 
average  rate,  and  there  are  presumably  many  instances  of  very 
much  higher  rates.  The  average  commission  which  it  is  neces- 
sary to  pay  to  the  middleman  or  intermediary  exceeds  2  per 
cent  a  year  in  certain  districts  of  North  Dakota,  Oklahoma, 
and  North  Carolina.  The  average  rate  for  interest  and  other 
costs  on  loans  to  farmers  on  personal  security  exceeds  10  per 
cent  in  twenty  states  and  rises  to  15.6  per  cent  in  Oklahoma, 


AGRICULTURAL   PROBLEMS  611 

13.8  per  cent  in  New  Mexico,  and  to  12.4  per  cent  in  Alabama. 
The  average  rate  exceeds  12  per  cent  on  57.3  per  cent  of  the 
loans  reported  in  North  Dakota,  on  55.3  per  cent  in  New  Mex- 
ico, 25.5  per  cent  in  Alabama,  and  34.7  per  cent  in  Colorado. 
Even  in  the  state  of  Michigan  5  per  cent  of  the  loans  on 
personal  security  cost  the  borrower  more  than  12  per  cent  a 
year.  Recent  investigations  made  by  the  Comptroller  of  the 
Currency  also  make  it  plain  that  in  some  sections  of  the  coun- 
try extortionate  rates  of  interest  are  being  charged  by  banks 
on  farm  loans  ;  and  that  in  some  districts  the  farmers  are  really 
being  exploited  by  rural  "  loan  sharks." 

American  farmers  not  only  pay  an  unnecessarily  high  price 
for  the  credit  which  they  receive,  but  it  is  not  supplied  in  the 
most  convenient  and  suitable  forms.  The  farmer  who  borrows 
to  buy  a  farm  or  to  construct  a  barn  wants  a  loan  for  more  than 
four  or  five  years  in  order  to  avoid  the  trouble  of  expense  and 
renewal,  with  the  periodic  danger  of  foreclosure.  The  loan 
should  run  in  many  cases  for  twenty-five  years  or  more;  the 
payment  should  be  arranged  so  that  the  principal  may  be 
gradually  extinguished  as  the  interest  is  paid,  and  the  farmer 
should  retain  the  right  to  extinguish  the  entire  principal  when- 
ever it  became  convenient  or  practicable  for  him  to  do  so.  In 
the  case  of  short-time  loans  on  personal  security,  similarly,  the 
farmer  does  not  want  a  sixty-day  or  ninety-day  loan,  the  kind 
of  accommodation  which  commercial  banks  prefer  to  give,  but 
needs  usually  a  loan  running  from  six  months  to  a  year,  in 
order  to  cover  the  waiting  period  between  planting  and  harvest 
time.  Moreover,  the  banks  in  some  sections  of  the  country  at 
present  force  farmers  who  borrow  from  them  to  specialize  in 
one  crop  —  a  money  crop  —  in  order  to  keep  the  security  in 
some  easily  realizable  form.  American  banks  have  in  this  way 
helped  to  prevent  the  adoption  of  diversified  farming. 

In  Europe,  agricultural  credit  is  furnished  at  low  cost  and  con- 
venient terms  by  a  series  of  mortgage  land  banks  and  farmers' 
loan  societies  or  credit  unions,  which  vary  greatly  in  detail  and 
structure  but  rest  upon  certain  common  fundamental  principles. 
Long-time  credit  is  provided  by  mortgage  land  banks,  the  oldest 


012  OUTLINES  OF  ECONOMICS 

form  of  which  is  perhaps  the  Prussian  Landscliaft.  These 
banks  lend  to  their  members  on  real  estate  mortgage,  and  then 
issue  bonds  secured  by  the  entire  body  of  mortgages  in  such  a 
way  as  to  replace  or  reenforce  each  individual's  credit  with  the 
credit  or  security  of  the  whole  group.  In  some  of  these  associa- 
tions all  the  property  of  the  members  is  pledged  for  the  support 
of  the  bonds,  but  experience  makes  it  plain  that  this  is  unneces- 
sary and  that  the  mortgages  themselves,  under  proper  manage- 
ment, afford  sufficient  security  to  insure  ready  sale  for  the  bonds. 
The  associations  or  banks  which  provide  short-time  credit  differ 
greatly  in  form.  Some  are  stock  companies,  receive  savings  de- 
posits, and  obtain  a  considerable  part  of  the  money  funds  which 
they  lend  from  stock  subscriptions  and  deposits.  In  others  a 
group  of  men  simply  pool  their  credit,  borrow  from  outside 
sources  on  their  unlimited  liability,  and  lend  the  proceeds  of 
these  loans  to  the  members  of  the  union.  Machinery,  organi- 
zation, and  rules  differ,  but  the  fundamental  principles  and  re- 
quirements are  as  follows : 

i.  A  pooling  of  credit  and  securities  so  that  the  debt  of 
each  member  is  backed  by  the  collective  credit  or  good-will  of 
the  association. 

2.  Rigid  scrutiny  of  the  loan  and  the  security  by  appraisers 
(usually  neighbors  of  the  borrower)  who  have  every  opportunity 
of  knowing  the  circumstances  of  the  borrower  and  the  value  of 
the  security  offered. 

3.  Limitation  of  credit  to  loans  for  productive  purposes. 
The  grant  of  credit  for  speculative  purposes  is  strictly  forbidden, 
and  many  societies  provide  that  loans  may  be  called  if  the 
money  is  not  properly  used. 

4.  Management  in  behalf  of  the  borrower.  This  represents 
the  most  essential  difference  between  the  cooperative  credit 
associations  of  Europe  and  the  credit  institutions  of  this  coun- 
try. Where  stock  is  issued,  each  stockholder  usually  has  only 
one  vote,  and  dividends  are  limited,  usually  to  the  rate  paid 
upon  borrowed  money.  Additional  earnings,  if  any,  are  turned 
into  a  surplus  fund  which,  if  the  union  is  dissolved,  goes  to  charity 
or  some  public  purpose. 


AGRICULTURAL   PROBLEMS  613 

5.  Adaptation  of  the  period  and  terms  of  the  loan  to  the 
needs  of  the  creditor,  with  provision  for  amortization  and  per- 
mission to  pay  off  the  loan  whenever  the  debtor  finds  it  possible. 

Cooperative  credit  associations  or  rural  banks  have  multi- 
plied rapidly  ail  over  Europe.  They  have  greatly  reduced 
rates  of  interest  to  farmers,  and  do  an  enormous  amount  of 
business  at  low  cost  and  with  very  little  loss.  Large  central  or 
district  associations  have  been  established  which  bring  the  rural 
societies  in  touch  with  city  money  markets,  help  to  procure 
funds  for  the  local  associations,  and  guide  their  activities  by 
constant  inspection  and  audit.  As  a  natural  corollary,  co- 
operative supply  associations  have  been  developed  in  many 
places,  which  furnish  fertilizers,  farm  machinery,  seed,  and  other 
supplies  to  members  at  the  lowest  possible  prices.  In  New 
Zealand  and  Australia  the  State  itself  has,  apparently  with 
entire  success,  undertaken  the  function  of  lending  money  to 
farmers  for  the  improvement  and  development  of  agricultural 
land.  In  this  country  a  few  states  have  adopted  laws  facili- 
tating the  formation  of  rural  credit  associations,  and  in  July, 
191 6,  the  President  approved  an  act  of  Congress  the  purpose 
of  which  is  well  indicated  by  its  longer  title :  "  An  act 
to  provide  capital  for  agricultural  development,  to  create 
standard  forms  of  investment  based  upon  farm  mortgage,  to 
equalize  rates  of  interest  upon  farm  loans,  to  furnish  a  mar- 
ket for  United  States  bonds,  to  create  government  depositaries 
and  financial  agents  for  the  United  States,  and  for  other 
purposes." 

This  law  represents  an  earnest  attempt  to  give  expression  to 
the  principles  set  forth  on  the  preceding  page.  The  machinery  is 
perhaps  necessarily,  but  unfortunately,  cumbersome.  The  law 
creates  a  hierarchy  of  land  banks,  the  control  of  which  is  cen- 
tralized in  a  Federal  Farm  Loan  Board  composed  of  the  Secre- 
tary of  the  Treasury  and  four  members  appointed  by  the  Presi- 
dent, to  serve  for  terms  of  eight  years.  This  board  is  to  be 
assisted  by  farm  loan  registrars  to  supervise  the  issues  of  farm 
loan  bonds  and  to  have  custodv  of  the  mortgages  and  securities 
upon  which  they  are  based ;  bv  land  bank  appraisers  to  deter- 


614  OUTLINES  OF  ECONOMICS 

mine  the  value  of  properties  offered  as  securities ;  by  "  as 
many  land  bank  examiners  as  it  shall  deem  necessary  " ;  and 
by  such  attorneys,  experts,  and  other  employees  as  are  required 
to  conduct  the  business  of  the  board.  The  country  is  to  be 
divided  into  twelve  districts,  in  each  of  which  there  shall  be  a 
Federal  Land  Bank  with  capital  stock  of  not  less  than  $750,000. 
The  government  is  to  supply  this  capital  unless  it  is  forthcoming 
from  other  sources,  thus  involving  the  government  in  a  maximum 
stock  subscription  of  $9,000,000.  Government  shares  are  to 
draw  no  dividends.  It  is  obviously  intended  and  hoped  that 
these  land  banks  shall  operate  through  small  National  Farm 
Loan  Associations  composed  of  persons  desiring  to  borrow 
money  under  the  act ;  but  in  case  such  loan  associations  are  not 
created  rapidly  or  widely  enough,  provision  is  also  made  for 
joint-stock  land  banks,  with  a  capital  of  not  less  than  $250,000, 
only  half  of  which  need  be  paid  in  cash  before  operations  are 
begun.  The  larger  federal  land  banks  are  also  authorized  to 
create  branches  and  if  necessary  to  lend  money  through  agents 
scattered  throughout  the  country. 

No  provision  is  made  for  loans  on  personal  property  or  per- 
sonal security.  Loans  must  be  secured  by  first  mortgages  not 
exceeding  in  amount  50  per  cent  of  the  value  of  the  land 
and  20  per  cent  of  the  value  of  the  improvements  thereon 
pledged  as  security.  Interest  rates  are  limited  to  6  per  cent ; 
proper  provision  is  made  for  the  amortization  of  the  principal 
while  the  interest  is  being  paid ;  the  loan  may  run  from  five  to 
forty  years  and  may  be  issued  only  to  a  person  who  is  "  at  the 
time,  or  shortly  to  become,  engaged  in  the  cultivation  of  the 
farm  mortgaged."  Such  loans  may  be  made  only  for  the  pur- 
pose of  purchasing  land  for  agricultural  uses;  to  provide  for 
the  purchase  of  equipment,  fertilizers,  and  live  stock ;  to  pro- 
vide for  buildings  and  the  improvement  of  farm  lands ;  or  to 
liquidate  the  indebtedness  of  the  owner  of  the  land  mortgaged. 

The  greatest  danger  of  such  legislation,  perhaps,  is  that  the 
extension  and  multiplication  of  credit  will  increase  the  demand 
for  land,  raise  its  price,  and  so  injure  the  very  classes  which  it 
is  designed  to  aid,  namely,  young  farmers  and  tenants  who  are 


AGRICULTURAL   PROBLEMS  615 

working  hard  to  acquire  title  to  the  farms  which  they  operate. 
Moreover,  there  is  an  important  connection  between  the  interest 
rate  and  the  price  of  land  which  must  be  considered  in  this 
connection.  Land  value  is  frequently  expressed  as  "so  many 
years'  purchase,"  i.e.  so  many  times  the  annual  rent  or  net  yield, 
the  number  of  years'  purchase  depending  upon  the  interest  rate. 
Roughly  speaking,  "  twenty-five  years'  purchase  "  corresponds  to 
a  four  per  cent  interest  rate,  "  twenty  years'  purchase  "  to  a 
five  per  cent  interest  rate.  If  we  reduce  the  interest  rate,  will 
we  not  automatically  increase  the  price  of  land? 

While  there  is  a  real  connection  between  land  values  and  the 
interest  rate,  it  does  not  follow  that  a  reduction  of,  say  one  fifth, 
in  the  interest  rate  will  be  followed  by  an  increase  of  one  fifth 
in  the  value  of  land.  The  interest  rate  which  largely  controls 
in  this  connection  is  the  rate  oh  purchase-money  mortgages, 
which  do  not  include  so  large  an  allowance  to  cover  risk  and 
similar  costs  as  do  the  other  and  smaller  farm  loans,  interest 
on  which  it  is  the  primary  purpose  of  this  legislation  to  reduce. 
In  consequence,  while  it  is  probable  that  improved  credit  will 
tend  to  raise  the  price  of  land,  it  is  almost  certain  that  the  in- 
crease will  not  be  commensurate  with  the  relief  to  the  farmer 
afforded  by  the  reduced  cost  of  loans. 

Tenancy  versus  Encumbered  Ownership.  —  At  this  point  it 
is  necessary  to  discuss  briefly  the  question  when  and  where  — 
if  ever  —  tenancy  is  to  be  preferred  to  land  ownership.  For 
though  it  may  come  as  a  surprise  to  some  American  readers, 
many  foreign  authorities  of  the  highest  rank  strongly  advocate 
tenancy  in  preference  to  ownership  when  land  has  become  very 
valuable.  In  the  expert  evidence  given  before  the  British  com- 
mittee of  1906  on  small  holdings,  for  instance,  the  balance  of 
opinion  seems  to  have  inclined  toward  tenancy  rather  than 
ownership. 

Here  again  we  meet  one  of  those  mixed  economic  and  psycho- 
logical questions  to  which  no  simple  answer  can  be  given.  In  a 
frontier  or  newly  settled  community,  there  is,  of  course,  little 
reason  for  tenancy  from  any  standpoint.  But  in  an  old  com- 
munity, where  land  values  are  high  and  are  as  likely  to  fluctuate 


616  OUTLINES  OF  ECONOMICS 

downwards  as  upwards  in  the  next  score  of  years  or  so,  the  eco- 
nomic arguments  in  favor  of  tenancy  are  exceedingly  strong  if 
not  altogether  convincing,  (i)  Under  such  circumstances  the 
farmer  who  insists  upon  holding  the  title  to  the  land  which  he 
tills  must  either  go  deeply  into  debt,  or  understock  his  farm,  or 
both.  To  underequip  the  farm  means  poor  agriculture;  and 
a  heavy  debt  hangs  like  a  millstone  around  the  neck  of  a  farmer 
when  land  values  are  not  on  the  increase.  The  tenant  farmers 
of  England  have  had  a  far  more  pleasant  time  since  1873  than 
the  small  landowning  farmers  whose  holdings  were  encumbered 
with  debt  at  that  time.  (2)  The  ownership  of  land  throws  upon 
the  farmer  all  the  responsibilities  of  the  speculative  entrepreneur, 
and  other  things  being  equal  —  if  they  can  ever  be  regarded  as 
equal  —  it  is  desirable  for  the  man  of  small  means  to  avoid 
these  responsibilities.  The  tenant  system  offers  a  means  of 
insurance  against  some  of  these  risks.  (3)  Such  insurance  be- 
comes all  the  more  advantageous  and  encumbered  ownership 
all  the  more  disadvantageous  because  of  the  well-known  faot 
that  land  yields  a  net  return,  year  by  year,  lower  than  almost 
any  other  form  of  property.  Part  of  this  is  due  to  the  social 
prestige  of  landownership  and  part  to  the  fact  that  over  very 
long  periods  the  small  annual  profit  on  land  is  likely  to  be  com- 
pensated for  by  an  increase  in  the  selling  value  of  the  land. 
Under  such  circumstances  landownership  is  partly  a  luxury  and 
partly  a  method  of  saving,  usually  for  the  descendants  and  heirs 
of  the  saver.  Both  factors  conspire  to  make  land  a  poor  invest- 
ment for  the  man  of  small  means.  He  cannot  afford  luxuries, 
on  the  one  hand,  and  he  must  find  a  business  calling,  on  the 
other  hand,  that  yields  him  a  quick  return.  (4)  And  finally,  it 
must  be  noted  that  the  question  of  tenancy  is  not  like  the  labor 
problem  which  has  developed  in  the  factory  industries.  The 
tenant  is  not  a  wage  earner.  He  may  be  as  independent  as  the 
manufacturer  who  hires  the  land,  buildings,  and  possibly  the 
machinery  with  which  he  works.  The  problem  of  tenancy, 
therefore,  has  no  necessary  relationship  to  the  problem  created 
by  the  existence  of  a  class  of  permanent  wage  earners.  The 
small  entrepreneur  still  holds  the  field  in  agriculture,  all  over 


AGRICULTURAL  PROBLEMS  blj 

the  world.  The  question  is  simply  whether  he  sha!)  hire  his 
plant  or  own  it. 

Notwithstanding  the  fact  that  tenant  farming  may  go  hand  in 
hand,  as  it  does  in  England,  with  good  farming,  and  notwith- 
standing the  desirability  of  reducing  the  speculative  risks  of  an 
industry  which  is  at  best  much  too  uncertain,  the  problem  can 
never  be  settled  on  economic  grounds  alone ;  and  if  we  add  to 
the  economic  virtues  of  ownership  its  social  and  moral  advan- 
tages, the  final  verdict  must  be  rendered  against  tenancy. 
Ownership  not  only  spurs  the  zeal  of  the  farmer,  dignifies  his 
occupation,  and  inculcates  a  love  of  the  soil  which  nothing  else 
inspires  in  so  great  a  degree,  but  it  gives  the  farmer  a  stake  in 
the  political  game,  steadies  him,  and  thus  improves  his  citizen- 
ship. It  is  perfectly  plain  that  ownership  cannot  be  enforced 
upon  a  people  that  are  not  prepared  for  it.  And  it  is  equally 
obvious  that  the  virtues  which  go  with  ownership  may  and  often 
do  degenerate  into  vices :  the  peasant  proprietor's  love  of  the 
soil  occasionally  becomes  land  worship,  his  thrift  avarice,  his 
conservatism  blind  fear,  and  his  industry  cruel,  —  he  drives 
himself  and  wife  and  children  at  a  pace  that  would  put  the 
sweater  to  shame. 

But  we  are  not  advocating  the  extension  of  landownership 
through  state  aid.  We  simply  call  attention  to  the  desirability 
of  fostering  those  qualities  which  lead  to  the  diffusion  of  owner- 
ship and  are  in  turn  strengthened  by  ownership ;  and  we  main- 
tain that  the  American  people  at  present  are  in  no  danger  of 
excessive  thrift  or  of  the  sordid  materialism  of  peasant  proprie- 
torship at  its  worst.  The  tendencies  and  the  dangers  are  almost 
all  in  the  opposite  direction.  If,  in  the  next  fifty  years,  the 
farmers  of  the  Middle  West  become  predominantly  tenants,  it 
will  not  be  because  tenancy  is  economically  and  socially  superior 
to  ownership,  but  because  the  farmers  of  that  district  have  not 
had  the  thrift  to  save  and  the  ability  to  adapt  themselves  to 
more  intensive  agriculture.  And  the  step  will  be  backward,  not 
forward.  The  popular  instinct  which  in  this  country  causes  an 
increase  of  tenancy  to  be  regarded  with  distrust  is  a  sound 
instinct. 


618  OUTLINES  OF  ECONOMICS 

A  minor  disadvantage  of  tenancy  is  found  in  the  fact  that  tenancy,  when 
it  becomes  predominant,  raises  difficulties  that  can  only  be  met  by  constant 
State  interference.  Short  leases,  with  no  indemnification  to  the  tenant  for 
the  improvements  which  he  has  made,  lead  to  rack-renting,  exhaustion  of 
the  soil,  and  class  hatred  between  landlords  and  tenants.  Long  leases,  on 
the  other  hand,  afford  insufficient  protection  to  the  landlord ;  because  when 
prices  are  high  the  tenant  thrives  and  pays  his  rent  promptly,  but  when 
prices  fall  rents  go  unpaid  and  the  landlord  has  no  real  redress.  In  Eng- 
land the  situation  has  been  met  by  a  system  of  short-time  leases  together 
with  compensation  to  the  tenant  —  a  legal  obligation  which  the  landlord 
cannot  escape  by  "contracting  out"  —  for  any  improvement  made  by  the 
tenant  whose  value  he  has  not  exhausted.  Neither  party  can  abrogate  a 
lease  without  a  year's  notice,  although  by  mutual  consent  this  may  be  re- 
duced to  six  months.  This  system  permits  rentals  to  be  adjusted  frequently 
as  prices  change,  rules  out  excessive  competition,  protects  the  landlord,  and 
warrants  the  tenant  in  making  any  improvement  required  by  good  farming, 
since  he  knows  that,  if  the  landlord  orders  him  out,  he  can  collect  on  his  de- 
parture the  actual  value  of  improvements  made  by  him,  whose  benefits  he 
has  not  had  time  to  reap.  In  practice,  the  incoming  tenant  usually  pays  for 
the  unexhausted  improvements,  and  disputes  are  settled  by  arbitration. 
Under  this  system,  "the  relation  between  landlord  and  tenant  is  very  satis- 
factorily arranged,  the  farmers  are,  as  a  rule,  contented  with  the  present 
system,  and  the  fields  of  England  prove  that  landownership  on  the  part  of 
farmers  is  not  essential  to  good  agriculture."  1 

Marketing  of  Farm  Products.  —  The  work  of  the  farmer  is 
not  finished  until  he  has  successfully  sold  his  produce.  Com- 
paring the  price  received  by  the  farmer  with  the  retail  price  of 
the  same  produce,  many  critics  have  complained  that  the  inter- 
mediate distributive  2  process  is  wasteful  and  expensive.  But 
careful  investigation  of  the  necessary  costs  of  marketing  does 
not  indicate,  on  the  whole,  that  our  distributive  system  is  so 
inefficient  as  to  call  for  complete  replacement.  Improvement  of 
present  methods,  and  not  revolution,  seems  to  be  the  proper 
solution. 

On  the  other  hand,  the  marketing  system  is  manifestly  defec- 
tive at  many  points.  The  farmer  himself  is  responsible  for  some 
of  the  most  costly  defects.  He  frequently  does  not  show  suffi- 
cient care  in  producing  the  exact  varieties  of  products  most  in 

1  H.  C.  Taylor,  The  Decline  of  Landowning  Farmers  in  England,  p.  61. 
*The  word  "distributive"  is  used  in  the  pjpular  sense  in  this  chafer. 


AGRICULTURAL   PROBLEMS  619 

demand,  or  in  sorting  and  crating  them  for  market  after  they 
have  been  produced.  Goods  are  carelessly  and  dishonestly 
packed ;  there  is  sometimes  a  dearth  of  buyers  and  sometimes 
a  monopolistic  agreement  among  buyers  at  country  points. 

There  is  also  room  for  improvement  in  the  transport  of  such 
goods  from  the  country  buying  point  to  the  wholesale  markets. 
Many  railroads  do  not  have  a  sufficient  supply  of  refrigerator 
cars  and  lack  facilities  for  handling  perishable  goods.  A  suffi- 
cient number  of  cars  is  frequently  not  provided  just  when  they 
are  most  needed,  there  are  many  avoidable  delays  in  transit,  and 
frequently  great  difficulties  in  adjusting  and  paying  claims  for 
damages.  Generally  speaking  also,  railway  tariffs  favor  through 
traffic  at  the  expense  of  local  traffic  and  are  thus  partly  respon- 
sible for  the  concentration  of  manufactures  and  population  in  the 
large  cities,  preventing  that  diffusion  of  people  throughout  the 
country  which  would  furnish  a  large  number  of  small  local 
markets. 

Among  the  wholesale  dealers,  particularly  the  commission 
houses,  there  is  also  room  for  improvement.  Fraud  and  sharp 
practices  have  been  common  in  the  past.  Well-organized  and 
convenient  markets  have  not  been  provided,  there  has  not  been 
enough  inspection  or  publicity,  and  where  the  goods  are  dis- 
posed of  at  auction  collusive  agreements  have  frequently  existed 
between  particular  traders  and  the  auction  company  itself. 

There  is  no  simple  or  general  remedy  for  these  conditions. 
In  order  to  secure  good  country  markets,  cooperation  among 
farmers  has  proved  successful  and  probably  offers  the  logical 
and  best  way  of  disposing  of  farm  products  at  country  points. 
Cooperation  has  also  been  used  successfully  in  the  market- 
ing of  perishable  goods,  and  here  the  commission  system  has 
been  partly  replaced  by  associations  of  farmers  or  growers  such 
as  the  California  Fruit  Growers  and  Shippers  Association,  which 
maintains  auction  rooms  in  eastern  cities  and  sells  its  own 
products  directly.  The  Southern  California  Fruit  Exchange  in  a 
few  years  reduced  the  cost  of  marketing  California  fruits  from 
10  per  cent  to  3  per  cent  of  the  selling  value. 

The  cooperative  marketing  association  and  the  intermediate 


620  OUTLINES   OF   ECONOMICS 

trader  who  buys  from  the  grower  and  sells  to  the  retailer  have 
in  common  two  points  of  superiority  over  the  commission  sys- 
tem. They  replace  the  lukewarm  interest  of  an  agent  by  the 
care  and  solicitude  of  an  owner,  and  by  shipping  in  large  quan- 
tities they  are  in  position  to  obtain  much  better  rates  from  the 
railways,  to  say  nothing  of  the  other  economies  effected  by 
handling  goods  on  a  large  scale.  The  cooperative  marketing 
associations  have  also  effected  great  economies  by  carefully 
studying  prices  in  the  various  markets  and  distributing  their  con- 
signments so  as  to  get  the  highest  prices  prevailing  at  the  time. 
The  independent  trader,  however,  can  select  the  most  avail- 
able market  even  more  successfully  than  the  cooperative  asso- 
ciation, and  speaking  generally  we  do  not  expect  to  see  the 
commission  house  displaced  by  a  cooperative  machinery  which 
transfers  products  direct  from  the  farmer  to  the  retailer.  An 
intermediate  mechanism  is  probably  necessary.  It  is  a  logical 
and  probably  an  economical  manifestation  of  the  division  of 
labor.  The  actual  purchaser  or  trader,  however,  will  probably 
slowly  displace  the  commission  man ;  and  there  can  be  little 
doubt  that  the  farmer  has  gained  enormously  by  the  substitu- 
tion of  the  trader  for  the  commission  house  in  the  marketing 
of  the  great  staple  products.  The  trader  comes  almost  to  the 
door  of  the  farmer  with  constant  bids  for  his  grain.  He  is  an 
expert  in  railway  rates,  is  in  constant  telegraphic  communica- 
tion with  the  great  markets  of  the  world,  and  handles  products 
in  such  large  quantities  as  to  reduce  intermediate  expenses  to  a 
minimum.  Occasionally,  as  has  sometimes  been  the  case  with 
the  great  line-elevator  companies,  he  works  in  conjunction  or  in 
collusion  with  the  railways,  overbidding  the  small  grain  dealer, 
and  forcing  the  railways  to  grant  rebates  on  the  large  shipments 
which  he  commands.  Even  in  this  case,  the  farmer  gains  by  the 
size  and  efficiency  of  the  middleman  (though  the  small  dealer 
may  suffer)  because  part  of  the  economies  effected  —  even  those 
effected  by  discriminative  railway  rates  —  will  come  to  him  in 
the  long  run.  Cases  of  monopolistic  oppression  are  theoretically 
possible  when  there  is  only  one  buyer  and  one  railway  who  are 
in  collusion,  and  the  farmer  is  deprived  —  because  of  high  rail- 


AGRICULTURAL   PROBLEMS  621 

way  rates  —  from  shipping  his  products  elsewhere.  But  the 
loss  to  the  farmer  through  extortion  of  this  kind  has  in  general 
been  much  more  than  counterbalanced  by  the  striking  economies 
effected  by  the  great  trading  companies ;  though  this,  of  course, 
affords  no  justification  either  for  monopoly  or  railway  dis- 
crimination. Both  should  be  suppressed,  but  in  such  a  way  as 
to  save  for  the  farmer  the  distributive  economies  effected  by 
large-scale  handling. 

Finally,  the  government  can  be  of  great  assistance,  provided 
the  laws  under  which  it  works  are  passed  after  careful  investi- 
gation and  designed  to  improve  rather  than  revolutionize  exist- 
ing marketing  machinery.  Laws  have  been  passed  governing 
the  grain  trade,  cold-storage  warehouses,  future  trading  in 
cotton,  and  the  size  and  character  of  standard  packages.  More 
important  still  are  the  state  laws  providing  for  the  regulation  of 
commission  merchants  and  the  creation  of  marketing  com- 
missions. 

Space  does  not  permit  a  discussion  of  the  laws  regulating  com- 
mission merchants  passed  by  Minnesota  (1899),  New  York 
(1913),  and  other  states.  Speaking  generally,  commission  dealers 
under  these  laws  must  obtain  a  license  from  some  state  com- 
mission or  official  and  post  a  bond  for  the  benefit  of  consignors 
conditioned  upon  faithful  observance  of  the  law.  The  laws 
usually  require  licensees  to  keep  an  exact  record  of  the  circum- 
stances of  each  sale  and  to  make  returns  to  shippers  within  a 
very  short  period  after  each  sale.  Either  by  the  statute  itself 
or  by  administrative  ruling  it  is  quite  common  to  prohibit  the 
commission  dealer  from  buying  consigned  products  for  himself 
or  from  selling  them  to  any  other  corporation  or  firm  in  which 
he  has  an  interest.  Licenses  may  be  revoked  for  malpractice 
of  the  following  kinds :  making  false  charges  for  cartage, 
handling,  insurance,  or  other  services  not  actually  rendered ; 
failure  to  make  prompt  settlements  with  consignors ;  rendering 
false  statements  as  to  the  sale  or  condition  of  the  goods  on 
receipt ;  sending  out  false  information  concerning  prices  or 
other  market  conditions ;  maintaining  combinations  to  fix 
prices  ;   violating  or  neglecting  other  features  of  the  law.     Not 


622  OUTLINES  OF   ECONOMICS 

a  great  many  complaints  have  been  registered  under  the  Minne- 
sota law,  "  due  partly  perhaps  to  ignorance  of  the  law's  exist- 
ence, and  partly  to  a  feeling  that  it  is  hardly  worth  while  to 
proceed  under  it.  It  may  also  be  an  indication  that  there  has 
not  been  so  much  dissatisfaction  among  shippers  as  most  people 
imagine." *  According  to  most  competent  observers  these 
laws  have  exercised  on  the  whole  a  salutary  effect  and  promise 
greatly  to  improve  what  has  hitherto  been  one  of  the  weakest 
links  in  the  distributive  chain,  the  ineffective  commission  mer- 
chant. 

In  a  number  of  states  commissions  or  departments  have  been 
organized  for  the  purpose  of  improving  marketing  methods. 
For  the  most  part  these  commissions  have  not  accomplished 
any  very  concrete  results  up  to  the  present  time.  What  is  most 
needed  now  is  study  and  investigation  rather  than  an  attempt 
to  introduce  on  a  magnificent  scale  costly  cooperative  or  other 
schemes  whose  practical  efficiency  has  not  been  demonstrated 
either  by  practice  or  the  most  thorough  advance  study.  Much 
more  helpful  and  promising  is  the  federal  Office  of  Markets  and 
Rural  Organization,  which  by  its  careful  investigations  is 
gradually  laying  the  basis  for  a  scientific  correction  of  the  real 
defects  and  abuses  which  exist. 

Speculation. — The  modern  marketing  or  distributive  mecha- 
nism not  only  relieves  the  producer  of  a  large  part  of  the  specula- 
tive risk  which  attends  the  transmission  of  raw  material  from 
the  farm  to  the  consumer,  and  calls  public  attention  to  this  specu- 
lative element  by  collecting  or  concentrating  it,  but  it  is  respon- 
sible also  for  a  large  amount  of  unnecessary  speculation  which 
many  persons  believe  to  be  particularly  injurious  to  the  farmer. 
We  are  not  here  concerned  with  the  general  evils  of  speculation 
but  with  the  prevalent  belief  that  speculative  dealing  in  futures 
tends  to  reduce  prices.  "  What  is  generally  urged  is  that  the 
professional  short  seller,  by  his  sales  of  fictitious  wheat  or  cotton, 
creates  a  fictitious  oversupply  in  the  market,  which  is  just  as 
instrumental  in  depressing  prices  as  would  be  an  abnormally 

1  L.  D.  H.  Weld,  The  Marketing  of  Farm  Products,  p.  453.  The  discussion  at 
ihis  point  is  largely  based  upon  Professor  Weld's  admirable  book. 


AGRICULTURAL  PROBLEMS  623 

large  supply  of  actual  wheat  thrown  on  the  market  by  the 
farmer."  l  This  charge  is  frequently  supplemented  by  the 
assertion  that  it  requires  less  money  in  margins  to  "  sell  short " 
—  or  gamble  on  a  fall  in  prices  —  than  to  "  sell  long  "  in  antic- 
ipation of  a  rise,  and  that,  in  consequence,  the  weight  of  the 
speculative  dealing  in  farm  products  is  exerted  in  the  direction 
of  lower  prices. 

This  particular  charge  against  speculation  is  confirmed  neither 
by  a  priori  reasoning  nor  by  inductive  analysis.  Every  "  ficti- 
tious "  sale  of  wheat,  to  use  that  as  an  illustration,  must  be 
balanced  by  an  equivalent  "  fictitious  "  purchase.  The  "  bear  " 
who  sells  October  wheat  in  July,  even  though  he  may  hope  to 
depress  the  price  of  October  "  futures,"  exercises  no  harmful  in- 
fluence upon  the  actual  July  or  "  spot  "  price,  which  is  con- 
trolled by  the  demand  for  and  supply  of  actual  wheat ;  and 
when  October  comes,  "  the  short  seller  of  July  appears  now  as  a 
buyer  in  order  to  cover  his  contracts,  and  if  his  trading  has  any 
effect  on  the  market  at  all,  it  is  to  increase  the  demand,  not  the 
supply." 

It  is  very  plain  that  the  fictitious  market  may  be  artificially 
influenced  by  speculative  deals,  but  as  a  general  thing  the  ficti- 
tious market  is  ruled  by  the  actual  market,  not  vice  versa;  and 
the  only  influence  exerted  by  gambling  in  futures  upon  "  spot  " 
prices  (with  which  alone  the  farmer  is  concerned)  is  a  good  in- 
fluence. This  influence  arises  out  of  the  effect  of  future  trans- 
actions in  lessening  price  fluctuations  and  in  modifying  present 
use  by  anticipating  future  necessity.  And  the  complaint  that  it 
requires  less  capital  to  "  bear  "  the  market  than  to  "  bull  "  it, 
as  well  as  a  great  number  of  ingenious  criticisms  of  a  similar 
kind,  would  all  be  negatived  —  if  they  were  true  —  by  the  in- 
evitable consequence  that  any  permanent  factor  of  this  kind 
would  be  quickly  appreciated  by  specidators  and  fully  discounted. 
In  no  market  are  influences  of  this  kind  more  accurately  detected 
or  more  quickly  dissipated  by  competitive  forces  than  on  the 
produce  and  cotton  exchanges. 

1  N.  I.  Stone  in  the  Report  of  the  Industrial  Commission,  vol.  vi,  p.  189  ff.,  from 
which  other  quotations  cited  in  tliis  section  are  also  taken. 


624  OUTLINES  OF   ECONOMICS 

Actual  investigations  of  prices  confirm  the  theoretical  argu- 
ment made  above.  The  average  prices  of  spot  wheat  in  Sep- 
tember, October,  and  November  —  just  after  harvest,  when  the 
ordinary  farmer  is  compelled  to  sell  —  have  been  nearer  the 
average  price  for  the  entire  year,  since  the  speculative  wheat 
market  has  become  highly  organized,  than  in  the  forties  and  fifties 
when  wheat  was  sold  like  any  other  farm  product.  And  there 
are  reasons  for  the  belief  that  speculation  has  not  only  equalized 
yearly  fluctuations,  but  that  the  leveling  has  been  up,  not  down, 
in  the  interest  of  the  farmer  who  is  compelled  to  sell  after 
harvest,  as  opposed  to  the  wealthier  miller  or  trader  who  in  the 
past  carried  over  a  supply  for  the  lean  months.  "  It  is  not  un- 
commonly stated  that  in  the  last  few  years  futures  in  the  wheat 
market  have  not,  in  the  long  run,  stood  enough  above  '  spots  ' 
to  cover  all  the  expenses  of  carrying.  Some  suggested  reasons 
for  this  are :  cut  charges  for  storage ;  the  failure  of  outside 
speculation  to  maintain  the  market  against  hedging  sales ;  the 
fact  that  the  great  elevators  will  buy  wheat  and  carry  it  for 
what  they  can  get,  and  perform  the  functions  of  both  carrier 
and  trader  for  the  commission  of  one.  In  any  case,  the  tendency 
is  to  bring  all  prices  together."  x 

Not  only  does  "  speculation  "  tend  to  equalize  price  fluctua- 
tions between  different  points  of  time  and  between  different 
markets,  but  it  serves  the  exceedingly  useful  purpose  of  provid- 
ing a  "  body  of  professional  risk  takers  "  whose  function  is  to 
protect  the  actual  merchandiser  from  many  of  the  speculative 
risks  inherent  in  modern  business.  This  protection  against 
risk  is  secured  for  the  most  part  through  "  hedging,"  which 
has  been  defined  "asa  purchase  or  sale  for  future  delivery  in- 
tended to  offset  and  thereby  to  protect  an  actual  transaction 
in  merchandise."  The  terminal  grain  elevator  which  has  accu- 
mulated a  large  amount  of  grain  sells  a  corresponding  amount 
for  future  delivery  and  thereby  eliminates  nearly  all  of  the  specu- 
lative risks  involved  in  its  business.  The  miller  who  has  taken 
a  contract  to  deliver  flour  at  some  time  in  the  future  hedges  by 

1  H.  C.  Emery,  Speculation  on  the  Slock  and  Produce  Exchanges  of  the  United 
States,  p.  131. 


AGRICULTURAL   PROBLEMS  625 

buying  future  wheat  sufficient  to  produce  the  flour  called  for  in 
his  contract.  The  country  grain  buyer  who  knows  that  an  inter- 
val of  time  must  elapse  between  the  purchase  of  grain  and  its 
sale  at  the  point  of  destination  finds  similar  protection  in  a 
"  future  "  which  permits  him  to  specialize  in  the  distributive 
function  of  getting  grain  from  the  producer  to  the  ultimate  con- 
sumer with  a  minimum  of  speculative  danger.  There  are  simi- 
lar operations  in  the  cotton  market. 

Speculation  in  the  narrow  sense,  and  even  more  truly  the 
highly-organized  market  which  we  associate  it  with,  are  respon- 
sible for  a  certain  amount  of  harmful  gambling  which  should  be 
suppressed ;  but  in  their  ultimate  economic  effects  they  are 
highly  useful  institutions  designed  to  concentrate  the  uncer- 
tainties and  risks  inherent  in  the  very  nature  of  production  for  a 
future  market.  And  it  is  important  to  note  that  hedging,  the 
transaction  by  which  risks  are  eliminated  for  those  who  prefer 
to  specialize  in  the  less  dangerous  types  of  profit-seeking,  would 
be  impossible  without  the  more  speculative  traders  who  prac- 
tically bet  on  future  fluctuations  of  prices.  To  steady  and 
reduce  these  fluctuations,  provide  a  certain  market,  and  elimi- 
nate the  exploitation  of  the  ignorant  by  the  expert  traders, 
speculation  and  the  market  mechanism  which  it  requires  seem 
to  be  necessary  and  inevitable. 

QUESTIONS 

r.  Make  a  list  of  the  economic  factors  which  regulate  the  size  of  farms. 
Is  the  average  farm  likely  to  grow  larger  or  smaller  with  the  passage  of  time? 
Is  the  narrow  economic  conclusion  concerning  the  size  of  the  farm,  based 
upon  maximum  net  profit  to  the  individual  farmer,  subject  to  modification 
by  reason  of  social  or  moral  considerations? 

2.  Has  the  net  effect  of  the  rural  exodus  been  favorable  or  unfavorable 
to  agriculture  and  the  agricultural  classes?   to  society  generally? 

3.  Does  the  increase  of  tenancy  in  the  Southern  states  represent  progress 
or  retrogression?   in  the  North  Central  states? 

4.  Under  what  conditions  is  the  cash  rental  superior  to  share  tenancy? 
Would  the  "corn  rent"  —  a  sliding  rental  varying  with  the  price  of  farm 
products  —  be  superior  to  both?  Are  short  leases  better  than  long  leases 
for  the  landlord? 

5.  Do  the  farmers  in  your  locality  suffer  from  the  lack  of  credit  facilities? 


626  OUTLINES   OF   ECONOMICS 

Have  they  any  difficulty  in  finding  safe  and  convenient  investments  for  their 
savings  ? 

6.  What  is  the  advantage  of  specialized  farming  over  diversified  farming? 
Do  we  imply,  when  we  advocate  diversified  farming,  that  the  farmer  should 
"buy  nothing  that  he  can  raise  or  make  for  himself"? 

7.  Is  speculation  a  "necessary"  or  an  "unnecessary  evil"?  Is  it  an 
evil? 

REFERENCES 

Brace,  H.  H.     The  Value  of  Organized  Speculation. 

Commissioner  of  Corporations.    Report  on  Cotton  Exchanges,  Part  v. 

Butterfield,  K.  L.     Chapters  in  Rural  Progress. 

Carver,  T.  N.    Principles  of  Rural  Economics. 

Eleventh  Census.  Real  Estate  Mortgages;  Farms  and  Homes;  Proprietor- 
ship and  Indebtedness. 

Twelfth  Census.  Vol.  v,  Agriculture;  Supplementary  Analysis,  "The 
Negro  Farmer,"  pp.  511-579. 

Thirteenth  Census.    Vol.  v,  Agriculture. 

Coulter,  J.  L.     Cooperation  among  Farmers. 

Emery,  H.  C.  Speculation  on  the  Stock  and  Produce  Exchanges  of  the  United 
States. 

Haggard,  H.  R.    Rural  England. 

Herrick,  M.  T.,  and  Ingalls,  R.    Rural  Credits:  Land  and  Cooperative. 

Jebb,  L.     The  Small  Holdings  of  England. 

Marshall,  Alfred.    Principles  of  Economics,  6th  ed.,  Book  vi,  Chap.  x. 

Mill,  J.  S.    Principles  of  Political  Economy,  Book  ii,  Chaps,  vi-x. 

Morman,  J.  B.     Principles  of  Rural  Credits  (with  bibliography). 

Prothero,  R.  E.    English  Farming,  Past  and  Present. 

U.  S.  Department  of  Agriculture.     Year  Book;   The  Crop  Reporter. 

Industrial  Commission.     Report,  Vols,  vi,  x,  xi,  xix. 

Rogers,  A.  S.  L.     The  Business  Side  of  Agriculture. 

Rowntree,  B.  S.    Land  and  Labour:  Lessons  from  Belgium. 

Taylor,  H.  C.  A gricidtural  Economics ;  and  " The  Decline  of  Landowning 
Farmers  in  England,"  Bulletin  of  the  University  of  Wisconsin,  No.  96. 

Warren,  G.  F.    Farm  Management. 

Weld,  L.  D.  H.     The  Marketing  of  Farm  Products. 


CHAPTER  XXX 
SOCIALISM 

Socialism  Defined.  —  Socialists  seek  the  establishment  of  in- 
dustrial democracy  through  the  instrumentality  of  the  State. 
Our  political  organization  is  to  become  also  an  economic  indus- 
trial organization.  Socialism  contemplates  an  expansion  of  the 
business  functions  of  government  until  the  more  important 
businesses  are  absorbed.  Private  property  in  income-yielding 
capital  and  land  is  to  be  abolished.  Socialists  make  no  war 
upon  capital;  what  they  object  to  is  the  private  capitalist. 
They  desire  to  socialize  capital  and  to  abolish  capitalists  as  a 
distinct  class.  Their  ideal,  then,  is  not,  as  is  supposed  by  the 
uninformed,  an  equal  division  of  existing  wealth,  but  a  change 
in  the  fundamental  conditions  governing  the  acquisition  of 
incomes. 

Socialists  usually  say  that  labor  creates  all  wealth.  Land 
and  capital,  they  hold,  are  merely  passive  factors  of  production, 
and  their  owners  ought  not  to  receive  a  share  of  the  product 
unless  they  personally  are  useful  members  of  the  community. 
Labor  is  the  active  factor,  and  all  production  is  carried  on  for 
the  sake  of  man.  Land  and  capital  are  simply  the  tools  of 
man.  Socialists  admit  that  the  owners  of  these  tools  must 
receive  a  return  for  them  when  industry  is  organized  as  it  is 
now;  hence  they  desire  that  these  tools  should  become  public 
property.  They  wish  to  make  of  universal  application  the 
command  of  the  Apostle  Paul,  "  If  a  man  will  not  work,  neither 
let  him  eat." 

Distributive  Justice.  —  Socialists,  in  common  with  a  great 
many  other  people  who  do  not  accept  their  attitude  toward  the 
organization  of  industry,  desire  distributive  justice.  As  to  what 
constitutes  justice  they  are  not  wholly  agreed,  but  there  is 

627 


628  OUTLINES  OF  ECONOMICS 

among  them  a  tendency  to  accept  equality  of  needs  rather  than 
productivity  as  a  basis.  Some,  it  is  true,  have  advocated  an 
almost  mechanical  equality,  but  most  socialists  today  would 
regard  the  question  of  a  precise  standard  for  the  distribution  of 
income  as  not  of  present  importance.  They  are  simply  agreed 
in  this,  that  the  distribution  of  the  present  day  is  wholly  unjust. 
They  think  that  men  today  do  not  have  equal  chances  in  life 
and  that  there  is  too  much  special  privilege.  The  rewards,  they 
think,  today  go  to  those  who  are  shrewd  and  cunning,  who  are 
skillful  in  manipulating  stocks  and  bonds,  or  who  are  favored 
by  inheritance  with  a  good  start,  rather  than  to  those  who 
render  great  social  service.  The  inventors,  poets,  authors, 
scientists,  skilled  mechanics,  and  factory  managers,  they  allege, 
are  the  large  producers,  but  they  do  not  get  the  big  prizes. 

Varieties  of  Socialism.  —  The  foregoing  characterization  ap- 
plies to  most  persons  who  have  been  called  socialists,  but  the 
genus  contains  a  number  of  species  which  should  be  distinguished. 

i.  One  group  has  been  called  "  Utopian."  This  first  group 
contains  those  who  have  become  impressed  with  the  evils  of  the 
present  competitive  system  and  propose  the  collective  owner- 
ship of  the  means  of  production  as  a  remedy,  in  much  the  same 
spirit  with  which  a  physician  writes  a  prescription  to  cure  his 
patient.  There  have  been  many  attempts  to  picture  to  us  how 
smoothly  things  would  proceed  if  men  could  only  be  persuaded 
to  adopt  the  collective  ownership  of  land  and  capital.  As  a  type 
of  this  class  we  may  take  Robert  Owen.  His  life  was  contem- 
poraneous with  the  Industrial  Revolution  in  England,  he  him- 
self being  a  successful  manufacturer.  He  saw  with  his  own  eyes 
the  evils  of  unrestricted  competition,  and  was  filled  with  an 
earnest  desire  to  better  the  condition  of  the  working  classes. 
He  is  remembered  as  a  factory  reformer  and  promoter  of  volun- 
tary cooperation,  but  yet  he  regarded  these  efforts  as  not  suffi- 
ciently radical.  He  thought  human  nature  must  be  reformed 
by  careful  training  from  childhood  in  an  atmosphere  of  associa- 
tion, instead  of  in  the  self-seeking,  commercial  atmosphere 
which  surrounded  him.  He  spent  his  large  fortune  in  an  at- 
tempt to  carry  out  his  ideas  regarding  the  reconstruction  of 


SOCIALISM  629 

society.  Among  his  projects  was  the  founding  of  a  colony  at 
New  Harmony,  Indiana,  where  no  private  property  or  com- 
petition should  exist.  After  a  struggle  of  two  years,  the 
experiment  ended,  as  most  other  similar  enterprises  have,  a 
complete  failure.  In  this  group  would  also  be  placed  Saint- 
Simon,  Fourier,  Cabet,  Blanc,1  and  Bellamy. 

2.  The  "  Marxian  "  socialists  call  themselves  "  scientific," 
as  distinguished  from  the  idealistic  writers  just  mentioned. 
They  insist  that  they  have  no  cure-all  for  the  ills  of  society. 
Socialism  in  their  eyes  is,  in  the  main,  only  an  explanation  of 
what  is  happening.  The  private  capitalistic  system  is  breaking 
down,  they  say,  and  the  logical  result  must  be  the  collective 
ownership  of  the  means  of  production  as  the  next  stage  in  social 
evolution.  They  say  that  setting  aside  all  question  of  "  ought  " 
or  "  desirability,"  collective  ownership  is  coming,  and  we  might 
as  well  adjust  ourselves  to  it.  The  four  leading  features  of  the 
Marxian  philosophy  are :  (1)  the  view  of  society  as  an  evolu- 
tionary product ;  (2)  the  economic  interpretation  of  history, 
according  to  which  our  whole  social  life,  including  our  ideas  con- 
cerning religion,  art,  marriage,  etc.,  are  but  a  reflex  of  past  and 
present  economic  conditions ;  (3)  the  doctrine  of  surplus  value, 
according  to  which  the  income  of  the  capitalist  class  does  not 
represent  a  return  for  the  sacrifice  of  "  abstinence  "  or  "  wait- 
ing," but  results  from  the  fact  that  through  the  ownership  of 
the  means  of  production  its  members  can  compel  the  laboring 
class  to  work  a  longer  number  of  hours  than  is  necessary  to  pro- 
duce the  wages  which  the  laborers  receive,  what  is  produced 
in  this  additional  number  of  hours  being  the  source  of  capitalist 
income ;  and  (4)  the  doctrine  of  the  class  struggle,  which  finds 
a  deep  antagonism  between  the  capitalist  class  and  the  laboring 
class,  that  can  only  result  in  the  overthrow  of  the  former. 
Most  socialists  now  believe  that  this  victory  will  be  won  with- 
out bloodshed,  as  a  result  of  a  gradual  increase  in  the  strength 
of  the  socialist  party  as  a  political  organization. 

3.  The  Fabian  Socialists,  of  whom   the   members   of    the 

1  Louis  Blanc  was  less  " Utopian"  than  the  others.  He  was  transitional  and  in 
reality  paved  the  way  for  the  German  and  later  "scientific"  movement. 


630  OUTLINES  OF   ECONOMICS 

Fabian  Society  of  England  are  types,  have  disapproved  both  of 
the  founding  of  Utopian  settlements  and  of  the  philosophy  of 
Marx.  The  aim  of  this  society  has  been  to  spread  socialistic 
ideas  by  the  dissemination  of  knowledge  on  the  subject,  rather 
than  by  an  organized  political  movement,  advocating  this  or 
that  reform  as  opportunity  indicated.  The  membership  has 
come  largely  from  the  educated  middle  class,  and  has  never 
been  very  large,  although  the  society  has  exercised  a  very  great 
influence.  Practically,  the  views  of  the  more  conservative 
socialists  in  France  and  Germany  do  not  differ  greatly  from 
those  of  the  Fabians. 

The  following  words  of  the  late  Jean  Jaures  on  the  method  of 
realizing  the  socialist  ideal  are  of  interest  in  this  connection : 

"All  Socialists,  indeed,  some  openly,  others  with  infinite  precautions, 
some  with  a  mischievous  Viennese  good-nature,  declare  it  to  be  untrue  that, 
taken  as  a  whole,  the  economic  material  condition  of  the  proletariat  is  get- 
ting worse  and  worse.  It  must  be  conceded,  after  taking  account  of  the 
tendency  to  sink  and  the  tendency  to  rise,  that  in  the  immediate  reality  of 
life,  the  tendency  to  sink  is  not  the  stronger.  Once  this  has  been  granted, 
it  is  no  longer  possible  to  repeat  after  Marx  and  Engels  that  the  capitalist 
system  will  perish  because  it  does  not  insure  to  those  whom  it  exploits  the 
minimum  necessities  of  life.  It  follows  from  the  same  admission  that  it  has 
also  become  puerile  to  expect  that  an  economic  cataclysm,  menacing  the 
proletariat  in  its  very  existence,  will  bring  about,  by  the  revolt  of  the  instinct 
of  self-preservation,  the  'violent  overthrow  of  the  bourgeoisie.' 

"It  is  not  by  an  unexpected  counter-stroke  of  political  agitation  that  the 
proletariat  will  gain  supreme  power,  but  by  the  methodical  and  legal  organi- 
zation of  its  own  forces  under  the  law  of  the  democracy  and  universal  suf- 
frage. It  is  not  by  the  collapse  of  the  capitalistic  bourgeoisie,  but  by  the 
growth  of  the  proletariat,  that  the  Communist  order  will  gradually  install 
itself  in  our  society."  l 

4.  The  Christian  socialists.  About  the  middle  of  the  nine- 
teenth century,  such  men  as  Kingsley,  Maurice,  and  Hughes  in 
England  were  much  impressed  by  the  misery  of  the  poor,  and 
they  attacked  the  competitive  system  as  being  responsible  for 
the  evils  which  they  saw.  Voluntary  cooperation  and  the  ele- 
vation of  the  workingman's  character  seemed  to  them  the  proper 

1  Studies  in  Socialism  (trans,  by  M.  Minturn),  pp.  167-169. 


SOCIALISM  631 

remedies.  Thus  their  theories  do  not  fall  under  the  head  of 
socialism  as  we  have  defined  the  term.  There  is  another  group 
who  believe  that  the  ideals  of  Christianity  can  only  be  realized 
through  the  abolition  of  private  capitalism.  In  Germany  and 
in  France  socialist  movements  have  been  organized  by  adherents 
of  both  Protestant  and  Catholic  churches.  In  the  United  States 
there  has  been  no  similar  movement,  although  we  find  the  term 
Christian  socialist  occasionally  employed. 

5.  State  socialism  is  a  term  frequently  used  in  German  dis- 
cussion to  designate  the  views  of  those  who  favor  an  extension 
of  the  economic  functions  of  government  without  any  great 
change  in  existing  class  relations. 

6.  "  Socialism  of  the  chair  "  (Katliedersozialismus)  refers  to 
the  views  of  university  professors,  particularly  in  Germany,  who 
have  advocated  State  interference  with  property  rights  to  any 
extent  demanded  by  public  welfare,  and  have  opposed  the 
laissez-faire  doctrines  of  the  older  economists.  These  men  are 
not  to  be  classed  as  socialists,  the  term  being  used  as  a  reproach 
by  their  conservative  opponents,  and  the  designation  has  now 
chiefly  historical  significance. 

7.  Syndicalism  may  be  mentioned  here,  although  it  is  more 
akin  to  anarchism  than  to  socialism,  and  is  to  be  viewed  as  a 
form  of  labor  organization.  The  term  is  derived  from  the 
French  word  for  labor  union.  The  syndicalists  believe  that 
the  emancipation  of  the  working  classes  is  to  be  achieved,  not 
through  control  of  present  government,  but  by  means  of  the 
control  of,  first,  industry  and,  second,  government  by  labor 
unions.  They  advocate  the  use  of  general  strikes  and  of  other 
destructive  tactics,  such  as  sabotage.  They  are  extremely 
pessimistic  with  respect  to  the  outlook  for  the  laboring  classes. 
This  doctrine  had  its  highest  development  in  France  about 
1908  and  has  had  some  following  in  England  and  America. 
The  tactics  of  Syndicalism  are  condemned  by  the  American 
Socialist  Party. 

Communism.  —  Communism  was  the  term  employed  by  Karl 
Marx  to  distinguish  his  own  philosophy  from  the  "  Utopian  " 
schemes  of  such  men  as  Owen,  which  he  termed  socialistic.     But 


632  OUTLINES  OF  ECONOMICS 

today  the  reverse  has  become  the  common  usage.  Communism 
now  very  generally  signifies  the  abolition  of  private  property 
not  only  in  production  goods,  but  also  in  consumption  goods, 
whereas  socialists  contemplate  the  retention  of  private  property 
in  income.  In  this  case  there  would  be  provision  of  private 
property  for  every  one,  and  in  this  one  respect  socialists  em- 
phasize and  extend  the  idea  of  private  property. 

Socialism  an  Extension  of  Existing  Institutions.  —  Our  govern- 
ment owns  the  post  office;  most  governments  the  telegraph. 
Nearly  all  own  the  wagon  roads.  Some  own  the  canals  and  rail- 
ways. Many  governments  own  factories.  Probably  every 
national  government  does  at  least  a  little  manufacturing.  Most 
governments  cultivate  forests,  and  some  cultivate  arable  land. 
We  have  only  to  imagine  an  extension  of  what  already  exists 
until  government  enterprise  dominates  in  manufactures,  mining, 
transportation,  commerce,  and  carries  on,  in  short,  most  pro- 
ductive enterprises,  and  we  have  socialism. 

But  saying  that  socialism  is  an  extension  of  existing  institu- 
tions may  lead  to  a  misconception.  The  elimination  of  private 
capitalism,  it  is  supposed,  would  work  a  most  radical  change  in 
many  branches  of  our  social  life.  The  commercial  spirit,  social- 
ists think,  would  be  abolished,  and  with  it  all  that  is  dependent 
upon  it.  We  are  trained  today  from  childhood  up,  it  is  alleged, 
to  try  to  "  make  money,"  and  this  accentuates  the  selfish 
elements  in  our  nature ;  and  it  is  therefore  maintained  that  our 
present  system  does  nothing  to  promote,  and  does  much  to 
hinder,  the  development  of  the  brotherly  spirit. 

The  Strength  of  Socialism.  —  Socialism  makes  perhaps  its 
strongest  claim  in  its  plea,  first,  for  a  scientific  organization  of 
*the  productive  forces  of  society,  and  second,  for  a  just  distribu- 
tion of  the  annual  social  income.  *  It  is  said  that  the  present 
production  of  economic  goods  is  small  in  proportion  to  popula- 
tion, but  the  socialist  replies :  "  Naturally  enough.  Competition 
is  wasteful.  Two  railways  are  built  where  one  would  suffice. 
Two  trains  run  parallel  between  two  cities  where  one  would 
serve  the  public  equally  well.  Three  times  as  many  milk 
wagons,  horses,  and  drivers  are  required  to  serve  the  people 


SOCIALISM  633 

with  milk  as  would  suffice  if  the  milk  business  were  organized 
like  the  mail  distribution  in  cities.  Look  at  the  shops,  whole- 
sale and  retail,  and  see  the  waste  of  human  force.  Without 
competition,  the  dry  goods  business  and  the  grocery  business 
could  be  carried  on  with  a  third  of  the  present  expenditure 
of  energy.  Reflect  on  all  the  idle  classes  in  modern  society. 
Socialism  would  set  everybody  to  work,  and,  making  each  one 
dependent  on  his  own  exertions  for  success,  would  stimulate  all 
energies'."  The  argument  is  a  telling  one,  but  it  does  not  prove 
its  point  unless  we  grant  that  the  present  waste  $nd  idleness 
cannot  be  suppressed  or  greatly  diminished  without  a  departure 
from  the  fundamental  principles  of  our  present  industrial  order, 
or  that  the  waste  and  idleness  are  not  counterbalanced  by 
advantages. 

Justice  is  a  strong  plea  in  the  socialist  philosophy.  It  cannot 
be  for  one  moment  claimed  that  each  one's  income  is  at  present 
in  proportion  to  his  services  to  humanity.  Income  in  proportion 
to  industrial  merit  is  attractive  to  an  ethical  sentiment.  But 
cannot  we  approximate  justice  in  distribution  on  the  basis  of 
the  existing  order?  There  is  nothing  distinctively  socialistic 
about  the  desire  for  distributive  justice.  It  is  a  feeling  that 
actuates  those  who  work  for  the  control  of  monopolies,  for  tax 
reform,  for  regulation  of  inheritances,  and  for  labor  legislation. 
The  socialist  simply  differs  from  these  people  in  his  method  of 
attaining  his  ideal. 

The  socialist  criticism  of  the  present  regime  is  especially  severe 
in  the  matter  of  unemployment.  There  are  always  some  men 
able  and  willing  to  work  who  are  seeking  employment,  and 
periodically,  with  the  coming  of  crises  and  depressions,  the  lack 
of  employment  becomes  widespread.  Again,  it  is  urged  that 
today  goods  are  made  for  sale,  not  for  use,  as  they  would  be 
under  the  socialistic  regime.  Adulteration,  deception,  and 
"  cheap  and  nasty  "  goods  are  the  direct  outcome  of  a  system 
of  private  capitalism.  In  the  socialistic  state  we  are  told  the 
business  of  the  shopkeeper  is  to  help  you  find  what  you  really 
need ;  at  the  present  time  it  is  to  his  interest  to  persuade  you 
to  buy  what  you  do  not  need  or  what  will  give  him  the  greatest 


634  OUTLINES  OF   ECONOMICS 

profit.  The  spirit  of  competition  is  to  the  socialist  simply  war- 
fare. In  every  business  establishment  a  good  part  of  the  most 
highly  paid  labor  is  devoted,  not  to  the  production  of  goods,  but 
to  finding  a  market.  Ability  to  fight  one's  competitor  is  quite 
as  essential  in  business  as  is  the  ability  to  turn  out  good  products. 

The  Weakness  of  Socialism.  —  i.  Strong  as  may  be  the  fore- 
going indictment  of  the  existing  industrial  system,  it  is  not  suffi- 
cient to  indicate  that  socialism  is  to  be  the  necessary  or  the  desir- 
able outcome.  The  modern  machine  age  is  little  more  than  a 
century  old,  and  some  of  its  most  important  phases  are  very 
recent.  The  dire  predictions  made  by  Karl  Marx  and  his  fol- 
lowers on  the  strength  of  some  of  the  earliest  phenomena  of  the 
factory  system  have  not  been  borne  out,  and  similarly  the  evils 
of  today  may  possibly  be  very  largely  eliminated  without  de- 
parting from  our  fundamental  institutions.  In  short,  the  first 
weak  point  in  the  socialist's  position  is  that  he  attempts  to  pre- 
dict the  course  of  economic  evolution  too  far  in  advance.  That 
we  shall  have  a  juster  distribution  of  wealth  in  the  future,  and 
that  we  shall  eliminate  many  of  the  present  wastes  of  production 
seems  probable,  but  whether  this  will  be  accomplished  by  a 
socialistic  organization  it  would  be  very  hazardous  to  predict. 
It  is  desirable  to  have  ideals  to  work  toward,  but  we  should  not 
pin  our  faith  now  to  a  future  method  for  attaining  them,  for  no 
one  can  say  that  the  collective  ownership  of  all  of  the  important 
means  of  production  presents  a  question  that  needs  to  be 
decided  now. 

2.  The  socialist  underestimates  the  efficiency  of  the  present 
system.  In  particular  he  fails  to  see  the  significance  of  the  great 
and  (in  many  respects)  smoothly-working  system  of  economic 
cooperation  that  has  resulted  from  giving  opportunity  to  free 
individual  enterprise.  To-day  there  is  a  premium  on  energy 
and  thrift.  Much  may  be  wasted,  but  much  is  also  produced. 
That  socialism  would  result  in  a  larger  sum  total  of  goods  for 
consumption  has  never  been  proved.  But,  on  the  other  hand, 
we  can  say  that  the  present  regime  is  continually  offering  more 
and  more  to  the  mass  of  the  people.  Their  standard  of  life  is 
continually  rising.     Our  economic  world  is  a  bettering  world. 


SOCIALISM  635 

3.  The  socialist  is  also  in  other  respects  too  pessimistic  with 
respect  to  the  present.  He  sees  all  of  the  starvation,  misery, 
luxury,  and  extravagance,  but  he  passes  by  the  millions  of  happy 
homes  scattered  throughout  the  land.  He  does  not  see  that  the 
world  is  full  of  opportunity  for  the  rising  generation,  that  even 
if  the  chance  for  the  ownership  of  an  independent  business  for  the 
ordinary  man  is  smaller,  the  things  which  he  can  enjoy,  if  he  is 
of  average  intelligence  and  energy,  are  much  greater  than  ever 
before  in  the  world's  history. 

4.  The  socialist  underestimates  the  importance  of  individual 
responsibility.  Today  a  man  is  confronted  by  the  stern  neces- 
sity of  making  his  own  way,  and  this  must  have  some  good  effect 
upon  character.  On  the  whole,  the  lazy  and  incompetent  are 
sifted  out.  Bad  heredity  and  a  lack  of  proper  training  are  the 
cause  of  a  good  part  of  economic  misfortune.  It  is  well  to  dis- 
tinguish the  criticism  here  made  from  the  common  error  of 
supposing  that  socialism  would  necessarily  crush  individuality 
and  that  all  would  be  compelled  to  dress  and  eat  alike. 

5.  The  socialist  underestimates  the  importance  of  free  enter- 
prise in  industry.  If  a  man  now  believes  that  he  can  develop 
a  certain  industry  that  will  satisfy  important  wants  of  the  people 
in  the  future,  he  does  not  need  to  secure  the  consent  of  some 
government  official  to  make  the  experiment.  The  possibilities 
of  a  free  and  spontaneous  development  should  be  safeguarded 
from  governmental  routine  to  every  possible  extent. 

6.  Perhaps  the  most  frequently  mentioned  objection  to  social- 
ism is  the  danger  to  liberty.  Under  socialism  there  would  be 
simply  the  public  sphere  of  employment,  and  there  is  reason  to 
fear  that  the  inability  to  escape  from  the  public  sphere  would 
compel  the  submission  to  onerous  and  tyrannical  conditions 
imposed  by  the  administrative  heads  of  the  business  in  which 
one  might  be  engaged.  The  socialists,  it  is  true,  have  a  re- 
joinder in  the  fact  that  this  objection  refers  to  liberty  in  the 
negative  sense  of  freedom  from  interference  rather  than  in  the 
positive  sense  of  the  power  to  have  and  to  enjoy  goods,  and  yet 
there  are  many  persons  who  fear  the  tyranny  of  the  majority. 
Those  in  whose  hands  political  and  economic  control  centered 


636  OUTLINES  OF  ECONOMICS 

would  have  tremendous  power,  however  they  might  be  selected 
or  appointed.  As  in  the  religious  sphere  in  the  past,  so  in  the 
economic  sphere  in  the  future,  we  may  find  that  compulsory 
cooperation  is  incompatible  with  human  nature. 

7.  The  Marxian  socialists  may  be  criticized  for  the  impor- 
tance which  they  attach  to  the  economic  interpretation  of  his- 
tory, for  the  validity  of  that  proposition  does  not  establish  the 
validity  of  the  socialist  contention.  Even  if  it  be  true  that  our 
social  life  is  a  reflex  of  our  economic  activity,  it  still  does  not 
necessarily  follow  that  our  economic  development  is  going  to  be 
such  as  will  land  us  in  socialism.  Their  doctrine  of  the  class 
struggle  also  does  not  give  an  accurate  account  of  existing  con- 
ditions. We  have  a  laboring  class  and  a  capitalist  class,  it  is 
true,  but  there  is  also  a  considerable  class,  perhaps  large  enough 
to  hold  the  balance  of  power  between  the  other  two,  which  does 
not  sympathize  exclusively  with  either  laborers  or  capitalists. 
Moreover,  we  have  yet  other  social  classes,  divided  from  one 
another  by  lines  that  cut  across  those  separating  the  capitalists 
and  the  laborers.  Race  is,  for  example,  the  basis  of  a  social 
classification  that  lessens  the  unity  and  cohesiveness  of  the 
laboring  class. 

Social  Reform.  —  There  are  those  who  recognize  the  strength 
of  the  socialist's  criticism  of  the  existing  economic  and  social 
order,  but  who  believe  it  wise  to  attack  the  various  problems 
confronting  us  one  at  a  time.  Social  reform  seems  likely  to 
accomplish  more  valuable  results  than  socialism.  We  have  a 
monopoly  problem  before  us  now.  Its  solution  may  involve  a 
considerable  extension  of  government  enterprise.  Why  not  con- 
centrate our  efforts  upon  that  problem  instead  of  making  up 
our  minds  now  whether  some  day  the  greater  proportion  of  the 
industrial  field  must  be  collectively  owned  and  managed? 

The  Socialist  Movement.  —  In  every  country  of  importance 
at  the  present  time  there  is  an  organized  socialist  movement. 
In  Germany  the  Social-democratic  party  is  the  largest  political 
party  of  the  empire,  having  polled  over  one  third  of  the  total 
votes  cast  in  181 2,  although  it  has  less  than  28  per  cent  of  the 
seats  in  the  Reichstag.  The  growth  in  votes  and  representation 
is  shown  in  the  following  table : 


SULJLAL1SM 


t>37 


Year 

Socialist  Vote  in  Germany 

Representatives 
in  Reichstag1 

1878 

437,100 

9 

1881 

312,000 

12 

1884 

550,000 

24 

1887 

763  100 

11 

1890 

1,427,300 

35 

1893 

1,786,700 

44 

1898 

2,107,100 

56 

1903 

3,010,800 

81 

1907 

3,259,000 

43 

1912 

4,250,400 

no 

Although  the  official  platform  of  the  party  adheres  strictly  to 
the  orthodox  Marxian  faith,  the  party  itself  has  worked  for 
many  reforms  tending  to  favor  the  lower  classes,  and  a  large 
element  of  the  party  (the  "  revisionist  "  wing)  is  in  favor  of 
putting  the  doctrine  of  the  class  struggle  and  complete  collec- 
tivism in  the  background,  and  laying  main  emphasis  for  the 
present  upon  social  reform.  In  France  there  are  a  number  of 
socialist  factions  of  various  degrees  of  radicalism,  nominally 
united  in  one  party,  the  factional  strife  being  one  of  the  promi- 
nent characteristics  of  the  movement  in  that  country.  Their 
combined  representation  in  the  Chamber  of  Deputies  is  about 
one  sixth  of  the  total  membership.  A  member  of  the  moderate 
group,  Millerand,  was  made  Minister  of  Commerce  (1899)  in 
the  Waldeck-Rousseau  cabinet.  Since  that  time  other  social- 
ists have  accepted  cabinet  portfolios,  but  as  individuals  and  not 
as  representatives  of  the  socialist  party.  In  a  number  of  French 
municipalities  the  government  is  almost  completely  socialistic 
in  personnel.  The  result  in  these  cases  has  been  an  increased 
public  activity  in  behalf  of  workingmen,  the  poor,  and  the  un- 
fortunate. 

In  Belgium  the  success  of  the  socialist  party  in  promoting  the 
cooperative  movement  has  been  striking.  In  England  no  one 
socialist  party  has  attained  the  prominence  of  those  in  Germany 


'The 


total  number  of  seats  in  the  Reichstag  is  sqj. 


638  OUTLINES  OF  ECONOMICS 

and  France.  Some  of  the  socialist  organizations  have  joined 
with  the  trade  unions  in  forming  a  Labor  Party,  which  in  1914 
had  39  representatives  in  Parliament.  In  the  United  States 
there  are  two  rival  parties,  the  Socialist  party  and  the  Socialist 
Labor  party  (of  minor  importance) ,  both  having  platforms  based 
upon  the  Marxian  philosophy.  The  list  of  socialist  officials  in 
the  United  States  in  1913  included  21  members  of  State  legisla- 
tures, 34  mayors,  and  612  municipal,  county,  and  school  officers. 
In  191 2  a  socialist  was  elected  to  Congress  from  Wisconsin. 
The  elections  of  19 14  also  resulted  in  the  choice  of  one  socialist 
member  of  Congress  (from  New  York).  In  191 2  the  presidential 
candidates  of  the  two  socialist  parties  polled  6.3  per  cent  of  the 
total  vote,  the  total  socialist  vote  at  four  recent  presidential 
elections  being :  1900,130,336;  1904,441,776;  1908,438,509; 
1912,  931,406. 

Socialists  have  rendered  good  service  by  calling  attention  to 
social  problems,  by  forcing  us  to  reflect  on  the  condition  of  the 
less  fortunate  classes,  by  quickening  our  consciences ;  also  by 
helping  us  to  form  the  habit,  acquired  by  few  as  yet,  of  looking 
at  all  questions  from  the  standpoint  of  the  public  welfare  and 
not  merely  of  individual  gain ;  finally,  by  calling  our  attention 
to  the  nature  of  the  industrial  functions  of  government  and 
helping  us  to  separate  rationally  the  private  industrial  sphere 
from  the  public  industrial  sphere.  A  number  of  questions  hav- 
ing no  connection  with  socialism  have  been,  even  by  socialists, 
not  infrequently  associated  with  it.  Atheism  and  free  love  may 
be  mentioned.  Socialists  generally,  however,  regard  religion 
and  marriage  as  changing  institutions. 

Anarchism.  —  In  contrast  with  the  socialist,  the  anarchist 
holds  that  the  ideal  social  arrangement  is  that  men  should  freely 
and  spontaneously  form  cooperative  groups.  The  anarchists 
attack  government  and  deny  the  right  of  one  man  to  exercise 
authority  over  another.  Freedom,  independence,  self-reliance, 
non-compulsion,  are  what  appeal  to  them.  Such  an  ideal  con- 
tains nothing  reprehensible,  but  its  complete  attainment  is  im- 
possible. Some  governmental  compulsion  seems  necessary  with 
human  nature  as  it  is  or  is  ever  likely  to  be.     The  anarchist  is 


SOCIALISM  639 

not  opposed  to  the  principle  c  1  association ;  he  simply  asks  that 
the  association  be  voluntary.  The  anarchist  ideal  is  thus  por- 
trayed by  Kropotkin : 

"This  society  will  be  composed  of  a  multitude  of  associations  federated 
for  all  the  purposes  which  require  federation ;  trade  federations  for  produc- 
tions of  all  sorts,  —  agricultural,  industrial,  intellectual,  artistic;  communes 
for  consumption,  making  provision  for  dwellings,  gasworks,  supplies  of  food, 
sanitary  arrangements,  etc. ;  federations  of  communes,  among  themselves, 
and  federations  of  communes  with  trade  organizations;  and  finally,  wider 
groups  covering  all  the  country,  or  several  countries,  composed  of  men  who 
collaborate  for  the  satisfaction  of  such  economic,  intellectual,  artistic,  and 
moral  needs  as  are  not  limited  to  a  given  territory.  All  these  will  combine 
directly  by  means  of  free  agreements  between  them,  just  as  the  railway 
companies  or  the  postal  departments  of  different  countries  cooperate  now, 
without  having  a  central  railway  or  postal  government,  —  even  though  the 
former  are  actuated  by  merely  egotistic  aims,  and  the  latter  belong  to  differ- 
ent and  often  hostile  states ;  or  as  meteorologists,  the  Alpine  clubs,  the  life- 
boat stations  in  Great  Britain,  the  cyclists,  the  teachers,  and  so  on,  com- 
bine for  all  sorts  of  work  in  common,  for  intellectual  pursuits  or  simply  for 
pleasure."  1 

Many  persons  class  anarchists  and  socialists  together  as  simply 
dangerous  persons.  One  thing  they  do  have  in  common,  and 
that  is,  discontent  with  existing  conditions.  Otherwise  their 
views  are  in  most  respects  radically  divergent. 

Anarchists  differ  among  themselves.  The  "  communist- 
anarchist  "  Kropotkin  has  advocated  revolutionary  tactics. 
Bakunine  and  Stirner  also  favored  the  use  of  violence.  The 
"  individualistic  anarchists,"  such  as  Tolstoi  and  Tucker,  have 
advocated  a  peaceful  policy  of  non-resistance.  Godwin  and 
Proudhon  may  be  called  anarchistic  reformers. 

QUESTIONS  AND  EXERCISES 

1.  Is  the  public  purchase  of  a  street-railway  system  socialistic? 

2.  What  is  the  attitude  of  socialists  toward  the  trust  problem? 

3.  Compare  the  Amana  Society  with  the  New  Harmony  Community. 

4.  What  is  meant  by  the  economic  interpretation  of  history?  Is  it  ac- 
cepted by  thinkers  who  are  not  socialists? 

5.  Can  the  socialist  be  said  to  have  a  distinctive  attitude  towards  war? 

1  Memoirs  of  a  Revolutionist,  pp.  398-399- 


640  OUTLINES   OF   ECONOMICS 

6.  What  is  the  relation  between  trade-unionism  and  socialism  in  the 
United  States? 

7.  How  should  one  measure  the  real  cost  of  the  supply  of  capital  in  a 
socialistic  state? 

REFERENCES 

Barker,  J.  E.     British  Socialism. 

Cross,  I.  B.     The  Essentials  of  Socialism. 

Ely,  R.  T.    Socialism  and  Social  Reform;  French  and  German  Socialism. 

Eltzbacher,  Paul.     Anarchism.     (Trans,  by  S.  T.  Byington.) 

Ensor,  R.  C.  K.  (Editor).    Modern  Socialism,  2d  ed.     (A  collection  of 

essays  by  leading  socialists.) 
Hillquit,  Morris.    History  of  Socialism  in  the  United  States. 
Hinds,  W.  A.    American  Communities.     (Descriptive.) 
Hughan,  J.  W.     The  Facts  of  Socialism. 

Jaures,  Jean.    Studies  in  Socialism.     (Trans,  by  M.  Minturn.) 
Kirkup,  Thomas.     History  of  Socialism. 
Kropotkin,  P.     Modem  Science  and  Anarchism. 
Le  Rossignol,  J.  E.     Orthodox  Socialism. 
Morris,  William.     News  from  Nowhere. 
Orth,  S.  P.     Socialism  and  Democracy  in  Europe. 
Rae,  John.     Contemporary  Socialism,  2d  ed. 
Seligman,  E.  R.  A.     The  Economic  Interpretation  of  History. 
Simkhovitch,  V.  G.     Marxism  vs.  Socialism. 
Skelton,  O.  D.     Socialism:   A  Critical  Analysis. 
Socialist  Party  Campaign  Book. 

Spargo,  John.    Syndicalism,  Industrial  Unionism,  and  Socialism. 
Tucker,  Benjamin.    Instead  of  a  Book,  2d  ed. 
Vizetelly,  E.  A.     The  Anarchists. 

Walling,  W.  E.    Socialism  As  It  Is;  The  Larger  Aspects  of  Socialism. 
Wells,  H.  G.    A  Modern  Utopia;  Socialism  and  the  Great  Statt. 
Zenker,  E.  V.    Anarchism. 


BOOK   III 
PUBLIC   FINANCE 


CHAPTER  XXXI 
PUBLIC   EXPENDITURES 

Nature  and  Significance  of  Public  Finance.  —  Public  finance 
deals  with  the  revenues  of  government,  with  their  expenditure,  and 
their  administration.  Public  finance  is  one  part  of  economics. 
Like  general  economics,  it  deals  with  the  means  for  the  satisfac- 
tion of  human  wants.  Some  of  our  wants  we  satisfy  in  one  way, 
some  in  another.  Some  we  satisfy  individually.  Some  we 
satisfy  through  private  associated  effort,  especially  through  the 
private  corporation.  Others  we  satisfy  through  public  collective 
effort,  that  is  to  say,  through  some  governmental  agency.  The 
wants  which  we  satisfy  through  governmental  agency  are  not  all 
of  them  so  peculiar  that  they  could  not  be  satisfied  either  through 
private  individual  activity  or  private  associated  activity.  Let  us 
take  the  case  of  watering  the  streets.  There  are  places  in  which 
the  streets,  in  so  far  as  they  are  watered  at  all,  are  watered  by  in- 
dividuals in  their  private  capacity,  each  man  watering  the  street 
in  front  of  his  own  house  with  his  own  hose.  There  are  other 
places  in  which  the  householders  join  together  and  pay  some 
one  to  water  the  streets  for  them,  and  do  this  privately.  There 
are  still  other  cities  in  which  the  city  government  employs  persons 
to  water  the  streets  and  pays  them  from  the  proceeds  of  taxation. 

There  are,  to  be  sure,  some  wants  which  are  satisfied  through 
governmental  agency  and  which  a  civilized  community  will  not 
allow  us  to  satisfy  privately.  This  is  the  case  with  those  wants 
which  are  satisfied  by  means  of  the  police  and  the  courts.  It  \? 
a  peculiar  function  of  government  in  modern  times  to  provide  the 
inestimable  blessing  that  we  call  security  of  person  and  property. 
This  requires  economic  resources,  just  as  the  satisfaction  of  the 
other  wants  mentioned  does,  and  public  finance  has  to  do  with 
the  provision  of  these  resources. 

64* 


644  OUTLINES  OF  ECONOMICS 

Public  finance,  then,  is  a  part  of  economics  because  it  deals 
with  the  satisfaction  of  wants  by  the  use  of  economic  resources. 
It  is  also  a  part  of  economics  because  it  has  its  influence  upon  the 
production,  the  distribution,  and  the  consumption  of  wealth. 
But  while  we  have  to  insist  that  public  finance  belongs  to  eco- 
nomics, it  is  more  separated  from  the  other  parts  of  economics 
than  they  are  from  each  other.  Inasmuch  as  it  deals  with  the 
satisfaction  of  wants  through  governmental  agency,  it  has  its 
own  peculiarities,  and  it  is  only  an  undue  emphasis  upon  these 
peculiarities  which  leads  some  writers  to  make  it  a  separate 
science. 

The  significance  of  public  finance  may  be  brought  before  us 
by  examination  of,  first,  the  increasing  amount  of  public  revenues, 
and  of,  second,  the  enormous  aggregate  of  these  revenues  at  the 
present  time.  Public  revenues  have  gone  on  increasing  during 
the  past  hundred  years  by  leaps  and  bounds.  An  illustration  is 
afforded  by  the  history  of  France.  Ninety  years  ago  the  public 
expenditures  of  France  reached  one  thousand  million  francs  for 
the  first  time,  or,  as  we  generally  say,  a  billion  francs.  There 
was  universal  astonishment  and  alarm,  just  as  there  was  when, 
for  the  first  time,  an  American  Congress  spent  a  thousand  million 
dollars  in  two  years.  Never  since  the  time,  however,  when  the 
public  expenditures  of  France  first  amounted  to  a  thousand  mil- 
lion francs  have  they  been  so  small.  Gradually  they  increased 
until  they  reached  two  thousand  millions,  never  to  pass  below 
that  mark ;  then  they  increased  until  they  touched  three  thou- 
sand millions ;  and  now  the  national  expenditures  are  nearly  four 
thousand  millions.  Public  expenditures  at  the  present  time, 
under  the  modern  government,  amount  to  more  than  a  tenth  part 
of  all  the  wealth  produced.1 

1  This  estimate  (that  public  expenditures  equal  one  tenth  part  of  all  the  wealth 
annually  produced)  has  been  given,  but  it  must  be  a  very  considerable  underestimate 
for  the  modern  nation.  We  in  reality  know  very  little  about  the  amount  of  wealth 
annually  produced  in  the  modern  nations  of  the  world.  But  such  data  as  we  have, 
and  familiar  observation,  are  sufficient  to  convince  us  that  the  wealth  produced  is 
not  ten  times  the  total  public  expenditures.  In  the  United  States,  according  to 
Starke  M.  Grogan,  chief  (Census)  Statistician  in  Charge  of  Wealth,  Debt,  and  Taxa- 
tion, the  total  expenditures  or  "total  governmental  cost  payments,"  including  the 


PUBLIC    EXPENDITURES  645 

Now  what  does  this  mean  ?  Does  it  signify  increasing  extrav- 
agance or  even  corruption?  Quite  the  contrary.  While  the 
modern  government  is  far  from  perfect,  it  is  throughout  the 
civilized  world  probably  better  than  it  ever  has  been  before. 
Taking  the  civilized  world  as  a  whole,  there  probably  never  was 
more  honest  government  or  more  efficient  government  than  there 
is  today.  What  it  really  means  is  this :  We  are  living  in  a  pe- 
riod of  increasing  public  cooperation.  We  think  we  find  it  more 
advantageous  to  satisfy  certain  wants,  growing  in  number  and 
significance,  through  public  cooperation  than  through  individual 
effort  or  private  cooperation.  This  is  the  chief  significance  of 
the  increasing  governmental  budget  throughout  the  civilized 
world.  Militarism  in  its  various  phases  is  the  chief  phase  of  pub- 
lic expenditures  that  is  disquieting.1  Educational  expenditures 
afford  a  good  illustration  of  the  general  tendency.  They  run 
up  into  the  hundred  millions  in  the  modern  nation,  whereas, 
previously  to  this  century,  they  were  insignificant.  Expendi- 
tures for  police  protection,  for  public  lighting,  and  for  sanitation 
are  things  which,  so  far  as  any  expenditures  of  magnitude  are 
concerned,  belong  to  this  century. 

Public  finance  has  still  another  significance.  Questions  of 
social  reform  are  now  connected  generally  with  financial  ques- 
tions just  as  formerly  they  were  with  constitutional  questions. 
Public  finance  has  become  the  central  fighting  place  for  social 
reform.  The  question  of  protection  has,  from  the  earliest  days 
in  this  country,  been  connected  with  public  finance.  Police 
regulation  has  also  been  connected  with  fiscal  measures.  The 
license  charge  for  the  privilege  of  selling  alcoholic  beverages 

national  government,  states,  territories  and  local  subdivisions  amounted  in  1913  to 
S.5, 284, 343, 266  or  $33.83  per  capita.  Professor  W.  I.  King  (Wealth  and  Income  of  the 
People  of  the  United  States,  p.  248)  estimates  the  average  income  in  the  United  States, 
for  the  year  igro,  at  S332  per  capita.  Public  expenditures  thus  appear  to  take  about 
10  per  cent  of  the  income  in  this  country.  In  England  the  per  capita  expenditure  of 
the  national  government  alone  was,  before  the  European  War,  over  $i5-5C>,  and  in 
France  over  Si  7.  The  10  per  cent  estimate,  then,  is  clearly  an  underestimate  for 
most  countries. 

1  This  topic  is  adequately  treated  by  Professor  Charles  J.  Bullock  in  his  article 
entitled  "The  Growth  of  Federal  Expenditures,"  Political  Science  Quarterly,  vol. 
xviii,  pp.  97-1 1 1. 


646  OUTLINES  OF  ECONOMICS 

furnishes  an  illustration.  The  scope  of  the  police  power  is 
expanding  in  the  United  States,  and  this  means  expansion  of  the 
field  of  public  finance.  The  discussion  of  public  expenditures 
reveals,  as  few  other  subjects  do,  the  nature  of  our  civiliza- 
tion. 

Public  and  Private  Expenditures  Contrasted.  —  There  is  a 
difference  between  public  and  private  economies  with  respect 
to  the  equilibrium  between  income  and  outgo.  Relatively, 
there  is  an  elasticity  of  government  revenues  and  an  inelasticity 
of  government  expenditures.  This  finds  expression  in  the  state- 
ment that  public  revenues  are  gauged  acccording  to  expenditures ; 
whereas,  in  the  private  economy,  the  household  expenditures  are 
regidated  by  income.  This  is  a  regular  rule  for  normal  conditions. 
It  is  abnormal  when  irregularities  in  public  income  lead  to  irregu- 
larities in  expenditures.  It  has  been  observed  by  a  critic  that 
this  principle  of  public  finance  is  true  in  a  legal  sense,  but  not  in 
an  economic  sense.  It  is  said  that  when  public  expenditure  is 
decided  upon,  then  we  legally  determine  the  income ;  but,  eco- 
nomically, the  expenditures  of  the  state  rest  upon  a  foundation 
as  elastic  as  that  of  a  private  person.1  It  is  true  that  in  public 
expenditures  there  must  be  a  balancing  of  gain  and  sacrifice,  and 
that  in  the  case  of  a  particular  expenditure  it  must  be  weighed 
over  against  all  other  possible  expenditures,  not  only  public,  but 
private.  The  rich  state,  undoubtedly,  will  incur  expenditures 
from  which  a  poor  but  prudent  people  will  probably  shrink.  On 
the  other  hand,  a  private  person  is  not  to  be  thought  of  as  neces- 
sarily spending  all  his  income,  even  if  he  gauges  his  expendi- 
tures by  income. 

Nevertheless,  roughly  speaking,  the  principle  has  significance 
because  of  the  priority  of  the  claims  of  the  State.  This  has  been 
well  brought  out  by  critics  of  Henry  George,  who  advocated  the 
appropriation  of  economic  rent  for  public  expenditures.  Some 
of  Mr.  George's  followers  have  replied  to  the  objection  that  eco- 
nomic rent  might  not  be  sufficient  for  public  expenditures : 
"  Then  the  State  must  curtail  its  expenditures  as  the  private  person 
would  do."     When  we  think  about  it,  we  find  that  certain  public 

1  Gustav  Cohn,  Finanzivissenschajl,  S.  184. 


PUBLIC   EXPENDITURES  647 

expenditures  must  be  made  and  must  take  prior  claim.  How- 
ever, when,  as  is  so  often  the  case  in  cities,  there  is  an  income 
strictly  limited  by  the  tax  rate,  we  have  a  situation  like  that  of 
a  man  with  a  limited  and  inadequate  income.  This  is  an  un- 
fortunate situation  for  cities ;  but  the  case  of  a  national  govern- 
ment which  did  not  have  a  prior  claim  upon  wealth  for  defense 
would  be  anomalous. 

Closely  connected  with  what  has  been  said,  we  find  various 
differences  due  to  the  sovereignty  of  the  State  and  its  perpetual 
life.  The  State  orders  a  citizen  to  give  up  a  part  of  his  possessions, 
and,  indeed,  frequently  fixes  the  prices  to  be  paid  for  them.  And 
a  peculiarity  of  the  prices  paid  by  all  states  for  property  and 
services  is  that  they  must  be  determined  by  criteria  of  fairness, 
inasmuch  as  by  the  very  hypothesis  competition  is  wanting 
wholly  or  in  part.  Consequently,  we  find  courts  and  legislatures 
much  occupied  with  the  determination  of  what  is  "  fair  and  rea- 
sonable." The  perpetual  life  of  the  State  has  to  be  kept  in  mind 
in  a  great  variety  of  expenditures.  It  is  the  special  function  of 
the  State  to  provide  for  future  generations,  and  this  is  seen,  for 
example,  in  forestry  and  in  care  for  rivers  and  harbors. 

There  is  a  difference  between  public  and  private  economies  in 
the  means  of  measuring  the  utilities  resulting  from  expenditures. 
It  is  at  once  admitted  that  all  expenditures  of  states  and  of  pri- 
vate persons  should,  in  a  large  sense,  be  productive.  Waste  is 
everywhere  an  economic  wrong,  but  productive  expenditures 
mean  simply  useful  expenditures.  What  the  State  produces  is 
largely  immaterial  services,  and  these  have  no  market  price. 
How  can  we  tell  whether  they  are  socially  profitable  or  unprofit- 
able? They  are  not  worth  while  if  they  result  in  a  sacrifice  of 
other  expenditures  which  would  yield  larger  satisfactions.  It  is 
a  special  function  of  the  legislative  body,  in  a  constitutional 
state,  to  decide  upon  the  relative  advantages  of  various  possible 
public  expenditures,  and  to  weigh  these  over  against  the  ad- 
vantages of  private  expenditures  which  might  have  been  made 
if  the  money  permitting  the  expenditures  had  been  left  in  private 
pockets.  When  a  certain  sum  is  taken  from  me  by  taxation,  it 
results  in  a  public  expenditure  instead  of  a  private  expenditure 


648  OUTLINES   OF   ECONOMICS 

which  might  have  been  made.  This  is  only  another  way  of 
saying  that  public  expenditures  are  largely  from  income  which 
is  derivative.  Private  individuals  secure  an  income  and  then 
yield  a  part  of  it  for  public  purposes.  These  contributions  are 
compulsory.  On  the  other  hand,  there  are  economists  who  look 
upon  the  State  as  a  factor  in  production,  and  hold  that  what  is 
paid  in  taxes  is  less  than  what  corresponds  to  the  cooperative 
activity  of  the  State  in  the  maintenance  of  law  and  order  and  in 
other  services.  The  special  social  significance  of  public  expendi- 
tures is  that  their  aim  is  inclusive,  normally  and  regularly ; 
whereas,  normally  and  regularly,  the  aims  of  private  expendi- 
tures are  more  or  less  exclusive.  A  public  library  contrasted 
with  a  scholar's  private  collection  of  books  illustrates  this  point. 

All  these  differences  are  considerable,  and  they  give  us  perhaps 
at  least  one  reason  why  business  men  are  so  often  a  disappoint- 
ment in  an  official  capacity.  The  public  financier  must  be  gov- 
erned by  the  public  point  of  view ;  and  there  are  many  points  at 
which  this  diverges  from  the  private  point  of  view.  The  true 
statesman  is  one  who  has  the  public  point  of  view,  and  yet  is 
able  to  avail  himself  of  the  knowledge  and  experience  of  private 
business. 

The  Proper  Proportion  between  the  Total  Income  of  Society 
and  Public  Expenditures.  —  We  notice  actual  changes  in  this 
proportion,  and  we  discover  that  further  changes  are  advocated, 
running  all  the  way  from  anarchism,  which  would  abolish  gov- 
ernment and  public  expenditures,  to  socialism,  which,  by  making 
production  and  distribution  public  functions,  would  make  public 
expenditures,  broadly  construed,  nearly  equal  to  the  total  wealth 
production. 

An  attempt  has  been  made  by  those  who  take  a  less  extreme 
position  than  either  of  these  to  give  an  estimate  of  what  is  a  large 
public  expenditure,  what  a  small  expenditure,  what  is  desirable, 
undesirable,  or  even  intolerable.  Generally  these  estimates  are 
made  with  respect  to  the  maximum  expenditure,  but  we  could 
equally  well  raise  the  question  with  respect  to  the  minimum. 
One  writer  speaks  of  public  expenditures  of  16  per  cent  as  aver- 
age, and  25  per  cent  as  excessive.     Another  regards  public  ex- 


PUBLIC   EXPENDITURES  649 

penditures  which  consume  15  per  cent  of  the  total  annual  wealth 
production  as  the  upper  limit.  In  our  American  practice,  we 
very  generally  attempt  to  fix  a  maximum  direct  tax  rate. 
But  these  limits  are  based  on  the  valuation  of  property  and  not 
on  income.  State  constitutions  very  frequently  also  limit  state 
expenditures,  as  well  as  the  expenditures  of  cities  and  other  local 
units.  For  local  purposes  in  the  United  States,  we  have  roughly 
a  tax  limit  of  \  t°  3  Per  cent  °f  the  value  of  property.  Total 
taxation  of  real  property  frequently  runs  in  the  United  States 
from  10  per  cent  to  even  20  per  cent  of  the  net  profits,  and  indeed 
not  infrequently  goes  far  beyond  that.  The  truth  is  that  it  is 
absolutely  impossible  to  give  any  general  answer  to  the  question, 
"  What  is  the  proper  proportion  between  the  total  income  of 
society  and  public  expenditures?  "  Variations  in  the  wealth  of 
a  country  have  to  be  considered,  and  these  mean  much  when  the 
question  of  additional  expenditure  is  raised.  Variations  in  tax 
systems  and  the  consequent  distribution  of  the  burden  of  taxa- 
tion make  a  wide  difference.  In  times  of  distress,  more  can  be 
expended  than  on  ordinary  occasions.  When  the  national  life 
of  the  State  is  endangered  in  a  war,  expenditures  will  be  incurred 
which  would  be  impossible  at  any  other  time,  simply  because  for 
any  other  reason  the  people  would  not  submit  to  the  sacrifice 
involved. 

But  there  are  other  points  of  view  which  go  still  deeper.  Why 
do  we  spend  money  at  all  through  the  State?  Obviously  to  sat- 
isfy needs.  How  much  we  should  spend  publicly  depends  upon 
what  needs  are  satisfied  publicly.  We  have  to  ask  and  answer 
the  question,  "  What  position  do  these  needs  hold  among  our 
needs  in  general?"  "Do  they  belong  to  our  necessities  or 
superfluities?  "  When  we  consider  public  expenditures  in  the 
broadest  terms,  we  must  take  into  account  the  amount  of  pro- 
duction which  is  carried  on  by  the  State  —  employing  this  term 
"  State  "  here  as  elsewhere  in  its  generic  sense.  If  the  railways 
(as  in  Germany)  are  state  railways,  a  larger  percentage  of  the 
expenditures  and  revenues  of  the  country  are  public  in  character 
than  would  be  the  case  if  they  were  privately  owned  and  operated. 
No  comparison  of  expenditures  of  various  countries  can  have  any 


650  OUTLINES  OF   ECONOMICS 

value  if  it  does  not  take  into  account  considerations  of  this 
kind. 

Professor  Adolph  Wagner  1  lays  down  this  rule,  which  is  help- 
ful in  answering  the  question  as  to  the  proper  proportion  between 
the  income  of  society  and  public  expenditures  for  any  particular 
time  and  place :  "  The  permissible  amount  of  public  expendi- 
tures, both  absolutely  and  relatively  considered,  wih  vary  di- 
rectly in  proportion  to  (a)  the  direct  economic  value  of  state  activi- 
ties ;  (b)  the  extent  to  which  these  promote  the  productive  power 
of  all ;  (c)  the  absolutely  free  social  income ; 2  (d)  the  part  of  the 
net  state  receipts  coming  from  the  quasi-private  acquisition 
(railways,  industries  in  general)  of  the  State  and  not  from  taxes."5 
Fortunately,  how  much  we  shall  spend  presents  itself  historically, 
that  is,  with  respect  to  historical  conditions,  and  has  reference  to 
increments  or  decrements  of  expenditure.  The  problem  is  far 
easier  of  solution  than  it  would  be  otherwise. 

In  fact,  except  as  a  concrete  historical  problem,  it  is  impossible 
to  state  how  great  the  public  expenditures  should  be.  We  are 
now  in  a  position  to  understand  why  it  is  that  the  nations  of  the 
world  have  not  been  ruined  by  expenditures  which  even  a  genera- 
tion ago  would  have  been  thought  absolutely  crushing,  and  one 
hundred  years  ago  would  have  been  inconceivable.  We  satisfy 
our  needs  to  an  ever  increasing  extent  through  public  agencies. 
This  finds  expression  in  the  law  of  increasing  public  expendi- 
tures, given  by  the  writer  from  whom  we  have  just  quoted. 

"  Comparisons  between  different  countries  and  different  periods 
show  regularly  among  progressive  nations  an  extension  of  public 
activities.  This  manifests  itself  extensively  and  intensively.  The 
State  and  its  subordinate  political  units  continually  undertake  new 
functions,  and  they  perform  their  duties,  old  and  new,  better  and  bet- 
ter. In  this  way,  that  is,  through  public  agency,  the  needs  of  the 
population,  especially  their  common  needs,  are  satisfied  to  an  in- 

1  Finanzu'issenschaft,  2te  A.,  Bd.  i.,  S.  65. 

2  I.e.  beyond  and  above  what  is  needed  for  subsistence. 

'  This  means  public  ownership  of  enterprises  which  are  so  conducted  as  to  yield 
profits.  All  the  profits  can  and  indeed  must  be  expended  for  public  purposes, 
whereas,  if  the  industry  were  private,  only  a  part  of  the  profits  could  be  taken  for 
public  purposes. 


PUBLIC   EXPENDITURES  65 1 

creasing  extent;  and  the  public  services  for  the  satisfaction  of  needs 
continually  improve  in  quality.  The  clear  proof  of  this  is  given 
statistically  in  the  increased  demands  made  by  tlte  State  and  tlie 
subordinate  political  units." l 

We  have  here  described  what  is  a  part  of  a  still  larger  move- 
ment, namely,  the  socialization  of  production  and  the  socializa- 
tion of  consumption.  It  is,  however,  the  socialization  of  con- 
sumption which  especially  confronts  us  in  public  expenditures. 
To  an  increasing  extent  what  is  consumed  by  the  family  is  pro- 
duced outside  the  family.  There  has  been  going  forward  a  great 
process  of  socialization,  and  this  finds  expression  in  part  in  public 
expenditures.  The  needs  of  the  family  are  satisfied,  in  increas- 
ing proportion,  not  by  the  private  economy,  but  by  the  public 
economy,  and  satisfied  also,  as  Professor  Wagner  points  out,  not 
in  accordance  with  the  principles  of  private  economy,  which  is 
service  for  service,  but  in  accordance  with  the  principles  of  the 
public  economy,  which  is  an  adequate  general  return  for  that 
which  is  received. 

We  have  to  do  with  what  we  may  also  call  socialization  of  sup- 
ply. We  do  not  protect  ourselves  against  physical  violence,  but 
are  protected  by  the  State.  We  do  not  educate  our  own  children ; 
they  are  educated  by  public  agency.  And  public  expenditures 
are  also  made  to  promote  art  and  all  the  higher  interests  of  life. 
The  services  which  the  federal  government  renders  us  in  the  post 
office  find  expression  in  public  expenditures.  Public  expenditures 
are  giving  us  more  beautiful  and  more  healthful  cities,  and  are 
satisfying  the  needs  which  arise  out  of  the  extensive  growth  of 
the  country,  in  its  expansion  geographically  and  in  the  size  of  the 
population,  and  also  the  needs  which  arise  from  an  intensive 
growth. 

The  significance  of  this  lies  partly  in  increased  state  activities 
and  partly  in  the  incidence  of  the  cost  of  the  services  under  con- 
sideration. The  poor,  who  could  not  themselves  have  pleasure 
grounds,  enjoy  public  parks,  and  these  are  maintained  at  public 
expense.  So  we  may  take  up  one  service  after  another  and  find 
that  wealth,  produced  in  accordance  with  the  principles  of  the 

1  Wagner,  Grundleguv  der  politischen  Oekonomie,  3te  A.,  Bd.  i,  S.  893. 


652  OUTLINES   OF   ECONOMICS 

private  economy,  is  consumed  in  accordance  with  the  principles 
of  the  public  economy,  and  that  is  very  largely  in  accordance 
with  needs  and  capacity  for  use.  The  whole  public  educational 
system,  from  the  country  district  school  to  the  modern  state 
university,  culminating  in  research  and  investigation,  admirably 
illustrates  this  principle. 

Extravagance,  Economy,  and  Parsimony  in  Public  Expendi- 
tures. —  After  a  definition  of  economy  in  Webster's  International 
Dictionary,  we  find  the  following :  "  Economy,  Frugality,  Parsi- 
mony. Economy  avoids  all  waste  and  extravagance,  and  applies 
money  to  the  best  advantage ;  frugality  cuts  off  indulgences,  and 
proceeds  on  a  system  of  saving.  The  latter  conveys  the  idea  of 
not  using  or  spending  superfluously,  and  is  opposed  to  lavishness 
or  profusion.  Frugality  is  usually  applied  to  matters  of  con- 
sumption, and  commonly  points  to  simplicity  of  manners. 
Parsimony  is  frugality  carried  to  an  extreme,  involving  mean- 
ness of  spirit  and  a  sordid  mode  of  living.  Economy  is  a  virtue 
and  parsimony  a  vice." 

We  must  have  clear  ideas  as  to  which  course  of  the  three  we 
shall  follow,  for  it  is  scarcely  to  be  taken  for  granted  that  we  shall 
follow  the  course  of  extravagance.  There  is,  however,  danger  of 
indifference  as  to  the  size  of  public  expenditures,  and  extrava- 
gance may  result  therefrom.  WTiile  scarcely  any  one  now  would 
deliberately  advocate  extravagance  so  far  as  the  general  princi- 
ple is  concerned,  extravagance  in  detail  might  be  advocated ; 
and,  in  fact,  in  practice  we  find  both  indifference  and  extrava- 
gance. Sometimes  the  idea  that  extravagance  brings  money 
into  circulation  has  found  favor,  and  especially  has  been  used 
for  the  justification  of  large  expenditures  by  royal  courts.  The 
same  idea  has  been  used  as  a  justification  for  luxury.  It  can, 
however,  find  no  support  in  economic  principles.  There  is  dan- 
ger of  extravagance  because  each  one  concerned  with  govern- 
mental expenditures  feels  that  what  he  spends  is  a  relatively 
small  matter,  and  indeed  it  is.  It  is  sometimes  thoughtlessly 
overlooked  that  when  many  are  spending,  "  small  waste  "  be- 
comes significant,  and  may  be  even  ruinous.  This  is  a  problem 
which  concerns  every  large  business,  and  it  requires  strict  and 


PUBLIC   EXPENDITURES  653 

wise  administration  to  avoid  the  two  extremes  of  wasteful 
extravagance  and  red  tape. 

Sectionalism  also  results  in  extravagance,  and  this  shows  itself 
badly  in  the  United  States  at  times.  Whatever  any  state  can  se- 
cure from  the  federal  treasury  is  often  looked  upon  as  so  much 
clear  gain.  This  was  clearly  brought  out  in  the  discussions  con- 
cerning the  repayment,  several  years  ago,  of  the  direct  tax  that 
had  been  paid  by  the  states  to  the  federal  government.  This  tax 
has  now  been  repaid,  but  many  states  gave  agents  large  and 
extravagant  sums  to  work  for  the  refund.  Sometimes  sectional- 
ism manifests  itself  even  in  cities.  In  one  section  of  the  city 
there  may  be  vigorous  efforts  to  secure  money  for  itself  without 
due  regard  for  the  general  interest. 

For  many  years,  in  this  country,  federal  taxes  were  laid  very 
largely  for  other  than  revenue  purposes,  and  there  was  no  care- 
ful balancing  over  and  against  one  another  of  probable  revenues 
and  probable  expenditures,  with  the  result  that  there  was  fre- 
quently a  large  surplus  in  the  federal  treasury.  There  never 
has  been  a  time  when  it  would  not  have  been  possible  to  have 
expended  wisely  the  entire  revenues  of  the  federal  government ; 
e.g.  the  telegraph  might  have  been  purchased,  and  educational 
expenditures  might  have  been  increased.  But  there  was  no 
demand  for  these  expenditures  strong  enough  to  prevail,  and  the 
outlet  was  found  along  the  lines  of  least  resistance,  or,  perhaps  it 
ought  rather  to  be  said,  along  the  lines  of  greatest  "  pull." 
We  may  then  lay  it  down  as  a  general  law  that  there  is  danger  of 
extravagance  "whenever  public  revenues  outrun  felt  needs. 

In  the  domain  of  local  government  it  is  possible  to  limit  taxes 
or  expenditures,  and,  as  stated  above,  American  statute  books 
are  full  of  laws  prescribing  maximum  rates  for  school,  highway, 
and  other  tax  levies.  These  laws  have  failed  in  the  past  because 
they  were  adjusted  to  our  prevailing  underassessment  of  prop- 
erty and  it  was  perfectly  easy  to  evade  them  by  raising  the 
assessment  a  little  closer  to  the  true  value.  More  recently, 
however,  Colorado  and  several  other  states  have  adopted  "  tax 
limit  laws  "  which  work  successfully.  Instead  of  limiting  tax 
rates,  the  total  tax  levy  or  the  total  expenditures  are  limited  to  a 


654  OUTLINES  OF   ECONOMICS 

certain  increase,  say  ten  per  cent,  over  the  tax  levy  or  total 
expenditures  of  the  previous  year ;  and  some  authority  — 
usually  the  state  tax  commission  —  is  empowered  to  raise  the 
normal  limit  in  "  cases  of  emergency  or  urgent  necessity." 
Tax  limit  laws  applied  in  an  arbitrary  way  may  cripple,  and  in 
some  cases  have  crippled,  municipal  governments  in  necessary 
and  desirable  expansions  of  public  activity ;  but  when  adminis- 
tered by  a  wise  board  or  commission  authorized  to  modify  the 
ordinary  limit  when  necessary,  they  are  capable  of  restraining 
harmfully  rapid  expansion  of  public  expenditures.1 

There  is  a  tendency,  especially  wherever  public  spirit  is  not 
highly  developed,  to  favor  parsimony,  and  to  regard  that  as  the 
best  administration  which  spends  least,  and  the  smallest  tax  as 
the  best  tax.  This  idea  was  particularly  encouraged  by  those 
who  looked  upon  government  expenditures  as  external  to  the 
life  of  the  people  —  as  if  they  were  expenditures  for  some  outside 
person.  This  idea,  indeed,  may  be  traced  back  to  monarchical 
government  and  to  a  time  when  royal  courts  consumed  a  large 
part  of  the  public  revenue.  The  smallest  expenditure  means 
the  accomplishment  of  the  fewest  purposes.  Parsimony  means 
meanness,  and  can  never  be  the  rule  either  of  public  or  private 
financiering.  Frugality  is  the  rule  when  it  is  a  necessity.  Econ- 
omy is  the  sound  rule ;  and  this  means  a  broad  and  liberal  policy 
and  a  husbanding  of  resources.  The  wise  citizen  judges  any 
particular  administration  either  in  the  nation  or  the  state,  not 
chiefly  by  the  amount  of  public  expenditures,  but  by  the  results 
of  public  expenditures,  appreciating  full  well  that  increasing 
public  expenditures  are  a  normal  condition  in  a  sound  and 
healthy  society. 

The  Development  of  Public  Expenditures.  —  It  is  instructive 
to  consider  the  historical  order  in  which  the  objects  of  public 
expenditure  appear.  This  order  throws  a  strong  light  upon  the 
evolution  of  industrial  society  and  of  civilization  in  general. 
This  is  an  almost  unworked  field  of  investigation,  but  it  is  an 
extremely  interesting  and  important  one.     This  order  can  be 

1  Sec  discussions  of  this  subject  in  State  and  Local  Taxation  (Proceedings  of  the 
National  Tax  Association),  Vol.  viil,  pp.  368-390,  and  Vol.  ix,  pp.  452-473. 


PUBLIC    EXPENDITURES  655 

presented  here  only  in  the  most  general  terms,  and  in  these 
terms  it  is  somewhat  as  follows :  Expenditures  for  (1)  external 
security;  (2)  security  within  the  community;  (3)  promotion 
of  material  interests ;  (4)  benevolence  (transferred  in  part  from 
the  Church  at  the  time  of  the  Reformation) ;  (5)  education  in  its 
various  phases ;  (6)  labor.  In  a  general  way  the  organization 
of  the  departments  of  the  federal  government  corresponds  with 
this  order.  In  1789,  the  Treasury,  War,  and  State  departments 
were  organized,  also  the  Department  of  Justice,  Supreme  Court, 
and  the  Navy  Department ;  the  Post  Office  Department  was 
organized  as  a  distinct  department  in  1829 ;  the  Department  of 
the  Interior  was  organized  in  1849;  the  Department  of  Labor 
as  a  separate  department  (without  representation  in  the  Cabinet) 
in  1889  ;  the  Department  of  Agriculture  as  a  separate  department 
(with  representation  in  the  Cabinet)  in  1889  ;  the  Department  of 
Commerce  and  Labor  (with  representation  in  the  Cabinet)  in 
1903.  In  19 1 3  Commerce  and  Labor  were  divided  and  given 
separate  representation  in  the  Cabinet.  The  modern  nation  has 
been  spending  an  increasing  proportion  of  its  resources  for  edu- 
cation. (We  use  "  nation  "  in  the  general  sense  here,  including 
all  the  subdivisions  of  the  nation.)  We  find  a  rapidly  increasing 
item  in  the  budget  of  the  modern  municipality  for  public  libraries, 
in  which  line  of  expenditure  the  United  States  is  leading  the 
world.  Lately,  in  the  modern  budget,  we  find  expenditures 
which  are  distinctively  for  the  promotion  of  the  interests  of 
labor. 

Most  interesting  it  is  to  observe,  within  the  last  few  years,  an 
expenditure  in  the  national  budgets  for  international  agreements 
and  arrangements  to  promote  the  interests  of  labor.  In  jgoo, 
the  International  Association  for  Labor  Legislation  was  formed, 
and  its  permanent  Bureau  was  established  at  Basle,  Switzerland, 
in  1 90 1.  As  the  competition  of  labor  and  capital  was  interna- 
tional, it  had,  in  the  opinion  of  many  careful  observers,  become 
necessary  to  safeguard  the  interests  of  labor  by  international 
agreements.  Consequently,  we  find  that  this  international 
association  receives  subsidies  from  most  European  governments, 
and  a  small  one  from  the  United  States  through  our  federal 


656  OUTLINES  OF   ECONOMICS 

Department  of  Labor.  And,  in  1905,  as  we  have  already  seen, 
an  international  treaty  was  entered  into  by  Italy  and  France 
for  the  advancement  of  the  interests  of  labor  and  for  mutual 
protection  of  employers.  Small  indeed  are  these  items,  but 
they  are  significant  as  beginnings. 

We  must,  however,  analyze  the  public  expenditures  of  the 
various  departments  more  carefully  to  understand  fully  the  order 
of  development  in  the  objects  of  public  expenditures.  The 
whole  expenditure  of  the  Department  of  Agriculture  is  an  expen- 
diture to  promote  material  well-being,  and  this  has  become  one 
of  the  great  departments  in  modern  government.  The  Depart- 
ment of  the  Interior  is  also  largely  concerned  with  expenditures 
to  promote  the  general  material  welfare.  We  have  in  the  De- 
partment of  Agriculture  such  divisions  as  forestry,  food  adultera- 
tion, botany,  seed  tests,  pomology,  entomology,  agricultural 
soils,  irrigation  investigations,  and  road  inquiry. 

We  cannot  lay  down  any  hard  and  fast  line  between  public  and 
private  expenditures,  because  there  is  a  perpetual  shifting  from 
the  satisfaction  of  wants  privately  to  the  satisfaction  of  wants 
publicly,  and  sometimes  even,  though  less  frequently,  the  reverse 
process.  The  railways  of  Prussia  were  once  private,  and  their 
receipts  and  expenditures  had  little  to  do  with  the  Prussian 
budget.  Now  the  receipts  are  public  receipts,  and  their  expen- 
ditures are  public  expenditures.  The  addition  to  the  budget, 
however,  does  not  mean  necessarily  an  additional  burden  on  the 
people.  Indeed,  if  the  people  are  well  served  and  served  for  a 
lower  price  than  formerly,  with  less  relative  cost  of  operation,  the 
burdens  of  the  people  have  been  lightened,  and  this  is  what  is 
generally  claimed  in  Prussia.  Let  us  take  the  case  of  a  city  in 
which  watering  the  streets  is  a  private  matter  paid  for  by  private 
subscription.  The  expenditure  becomes  a  public  expenditure 
when  the  city  takes  upon  itself  this  function,  but  if  the  public 
expenditure  is  no  greater  than  the  private  expenditure,  there  is 
no  additional  burden.  If  the  service  is  better  performed,  and  the 
total  burden  more  fairly  distributed  by  taxation  than  by  private 
subscription,  —  as  sometimes,  at  least,  happens,  —  there  is  a 
positive  gain.    The  increased  density  of  population  has  been 


PUBLIC   EXPENDITURES  657 

mentioned  as  a  cause  of  increased  public  expenditures.  A  suburb 
without  any  municipal  organization  may  maintain  electric  lights 
in  the  streets  by  private  subscription.  The  expenditure  appears 
in  no  public  budget.  This  suburb  secures  some  kind  of  a  mu- 
nicipal organization,  and  that  which  was  a  private  expenditure 
becomes  a  public  expenditure.  Again,  however,  there  is  no 
increased  burden  resting  upon  the  people ;  their  wants  are  satis- 
fied through  a  different  channel. 

When  we  compare  modern  times  with  ancient  times,  we 
find  that  an  increasing  proportion  of  the  public  expenditures 
are  incurred  for  objects  which  directly  benefit  the  people,  and 
relatively  a  decreasing  amount  for  objects  in  which  they  have 
comparatively  little  concern.  This  finds  most  striking  exem- 
plification in  a  comparison  of  the  budget  of  France  in  1789  1 
with  the  budgets  of  1906  and  1907,  which  we  take  merely  as 
typical  modern  budgets.1 


Expenses  — 1789 

LlVRES  * 

Cost  of  collection  and  reimbursements  (does  not  include  cost 
of  collecting  taxes  farmed  out)    ....          .... 

31,478.000 
l62,486,000 
80,527,O00 
29,560,000 
33,240,000 

Consolidated  debt  —  included  portion  made  up  of  annuities 

Interest,  etc.,  on  remaining  portion  of  debt 

Pensions 

Royal  family  and  princes 

Total 

337,291,000 

"  This  formed  the  total  deduction  before  provision  could  be 
made  for  general  service  of  the  government,"  in  which  the  vari- 
ous items  are  as  shown  in  the  accompanying  table.  It  will  be 
observed,  in  comparing  these  budgets,  that  the  French  court 
consumed  a  very  large  proportion  of  the  expenditures  of  1789; 
and  that  of  what  remained  a  very  large  proportion  was  consumed 
by  the  public  debt,  the  army  and  navy ;  and  that  for  education 

1  Necker's  "Budget,"  May,  1789,  rearranged  by  the  author  of  the  article  in  the 
Dictionnaire  des  finances. 

2  A  livre  is  slightly  —  say  2  per  cent  —  less  than  a  franc. 


658 


OUTLINES  OF  ECONOMICS 


and  the  promotion  of  general  welfare  the  expenditure  was  rela- 
tively insignificant.  A  study  of  the  table  on  the  next  page  re- 
veals one  of  the  reasons  why  it  is  that  France  is  able  to  sustain 
so  large  a  public  expenditure.  Wants  are  thereby  satisfied, 
and  what  is  expended  returns  to  the  people  in  services. 


Expenses — 1789  (Continued) 


Livres 


War 

Marine  and  colonies 

Foreign  affairs 

Justice 

Interior 

Financial  administration 

Public  works,  agriculture,  and  commerce 
Public  instruction  and  fine  arts    .     .     . 
Public  worship 

Total 

Brought  forward 

Grand  Total 


100,548,000 
40,900,000 
7,480,000 
6,353,000 
8,249,000 
5,801,000 
11,907,000 
1,227,000 
2,188,000 


184,653,000 
337,291,000 


521,944,000 


The  view  here  presented  of  public  expenditures  is  undoubtedly 
one  which  is  reassuring.  The  impression  must  not  be  gathered 
irom  this  that  there  is  no  need  for  care  and  watchfulness.  As 
public  expenditures  increase,  it  becomes  of  more  and  more  im- 
portance to  secure  wise  and  prudent  administration  of  all  our 
resources.  Wastefulness  becomes  more  serious  than  ever  before, 
and  the  benefits  from  excellence  in  administration  increase  cor- 
respondingly. Without  pronouncing  any  opinion  upon  what  is 
called  imperialism,  we  may  also  say  that  the  enormous  increase  in 
expenditures,  in  one  way  or  another  connected  with  war,  which 
we  have  seen  during  the  past  few  years,  cannot  be  viewed  with- 
out misgiving.  Even  if  there  is  no  danger  of  the  bankruptcy 
of  any  great  modern  nation,  the  thought  must  at  least  occur  to 
one  that  it  is  a  pity  that,  with  so  many  public  needs  unsatisfied, 
with  such  large  possibilities  in  the  way  of  improvement  of  educa- 


PUBLIC   EXPENDITURES  659 

Budget  Estimates  Voted  for  tiie  Years  1913  and  1914 


Branches  of  Expenditure 


Finance  :  public  debt  .     .     . 
President,  Chamber,  Senate 

Finances 

Justice ■  .     . 

Foreign  affairs 

Interior 

War 

Marine 

Merchant  marine     .     .     .     . 

Instruction 

Fine  arts 

Commerce  and  industry  .     . 

Labor,  etc 

Posts  and  telegraphs    .     .     . 

Colonies 

Agriculture 

Public  works 

Total 


1913 
Francs 


1,286 

20. 

358, 

58 

20 

141, 

983 

467; 

Qi' 

309 ; 

21. 

16. 
106 

344 ; 
105. 

55 
340 


423.922 
116,488 
948,853 
55IJ27 
668,037 

96l>939 
224,376 
176,109 
394.631 
139.995 
778,491 

792.379 
669,353 

3^.845 
535.393 
002,741 
905,255 


4,738,603,534 


1914 
Francs 


1,306 

20 

389 
61 

22 

I76 

1,203 

513 

97 

347 

21 

17 
106 
362 
109 

74 
358 


,585.021 
,006,738 

,243,907 
,017,461 

,879,749 
,949, 5!3 
,659,712 

,542,521 
,368,267 
.810,375 
,839,189 

,948,374 
,718,809 

.635,135 
,724,180 
769,222 
,944,912 


5,191,643,085 


tion  and  of  our  general  environment,  such  enormous  and  almost 
incomprehensible  aggregates  of  wealth  should  be  annually  ex- 
pended for  warlike  purposes. 

Development  of  Public  Expenditures  with  Respect  to  Regu- 
larity and  Irregularity.  —  Public  expenditures  are  regular  and 
irregular,  or  ordinary  and  extraordinary,  with  respect  to  their 
occurrence.  Whether  the  expenditures  are  regular  or  not  depends 
upon  the  nature  of  the  goods  and  services  for  which  they  are  in- 
curred. A  large  force  must  be  employed  in  the  army  and  navy 
and  civil  service ;  and  regular  expenditures  must  be  made  for 
these  branches  of  the  public  service.  On  the  other  hand,  there 
are  great  monumental  works  like  the  construction  of  a  capitol 
for  which  the  expenditure  is  irregular  in  character.  War, 
famine,  and  pestilence  occasion  irregular  expenditures.  It  is  to 
be  noticed,  however,  that  in  any  scientific  arrangement  regular 
expenditures  increase  and  irregular  expenditures  decrease.     This 


ooo  OUTLINES  OF  ECONOMICS 

is  particularly  the  case  in  a  large  country,  and  especially  so  when 
long  periods  of  time  are  taken  into  account.  It  is  an  end  to  be 
striven  for  in  the  interest  of  orderly  finance.  In  India  there  is  a 
regular  famine  fund  to  make  provision  for  the  recurring  famines, 
so  that  even  expenditure  of  this  kind  takes  on  the  character  of 
regularity.  The  longer  the  period  of  time  and  the  larger  and 
richer  the  country,  the  greater  the  possibilities  of  establishing 
regularity,  inasmuch  as  chance  elements  decrease  under  these 
circumstances.  The  construction  of  a  post-office  building  in  one 
city  is  an  unusual  event,  but,  when  the  United  States  as  a  whole 
is  taken  into  account,  it  is  quite  possible  to  provide  regularly 
for  post  office  buildings. 

It  is  further  to  be  noticed  that  preventive  measures  rather 
than  relief  measures  increase  regular  expenditures.  This  is  one 
argument  in  favor  of  constant  preparation  for  war.  The  war 
expenditures  are  smaller  and  less  disturbing  v;hen  they  come. 
It  need  not  be  remarked  that  this  financial  advantage  may  be 
secured  at  a  loss  otherwise.  Furthermore,  there !"  a  certain  con- 
flict of  interests  between  administration  and  legislation.  Those 
who  are  administratively  responsible  for  expenditu-^o  prefer  to 
have  budgets  voted  for  long  periods,  as  in  this  w?*  they  can 
accomplish  most  with  a  given  sum.  On  the  other  hand,  a  legisla- 
tive branch  of  government  desires  that  budgets  shoula  be'  voted 
for  short  periods  for  the  sake  of  stricter  control. 

It  is  also  to  be  noticed  that  the  constitutional  piovisiDns 
against  debts  in  the  states  of  the  American  Union  promote 
regular  expenditures.  Where  loans  are  not  possible,  it  is  fre- 
quently necessary  to  spread  expenditures  over  long  periods  in 
order  that  the  burden  may  not  be  too  great  at  any  one  time. 
.  This  may  happen  in  the  construction  of  public  buildings  and  of 
other  important  public  works,  certain  sums  being  appropriated 
each  year  for  a  series  of  years. 

Classification  of  Public  Expenditures.  —  Many  principles  of 
classification  have  been  adopted.  At  the  bases  of  all  of  these,  for 
countries  like  our  own  organized  along  federal  lines,  is  the  dis- 
tinction among  (i)  central,  (2)  intermediate,  and  (3)  local  units. 
In  the  United  States  the  central  would  be  the  federal,  the  inter- 


PUBLIC   EXPENDITURES  66 1 

mediate  would  be  the  separate  states,  and  the  others,  the  local. 
An  examination  of  expenditures  with  respect  to  these  units 
throws  a  good  deal  of  light  upon  our  general  political  evolution. 
It  especially  helps  us  to  determine  whether  or  not  there  is  a  tend- 
ency in  the  direction  of  centralization,  although  expenditures 
are  not  conclusive  evidence.  Fear  is  often  expressed  lest  the 
central  governments  should  expand  at  the  expense  of  local  gov- 
ernments. It  is  thought  by  some  that  we  are  living  in  a  period 
of  centralization.  Statistics  of  public  expenditure  do  not  bear 
this  out.  From  the  close  of  the  Civil  War  until  the  end  of  the 
nineteenth  century,  local  expenditures  increased  most  rapidly 
and  state  expenditures  least  rapidly.  Between  1903  and  191 3, 
however,  the  expenditures  ("  governmental  cost  payments  ")  of 
the  states  increased  106  per  cent,  while  those  of  incorporated 
places  with  8000  or  more  inhabitants  increased  only  103  per  cent, 
and  those  of  the  federal  government  only  54  per  cent.  The 
increase  in  state  expenditures  seems  to  have  been  due  to  general 
expansion  and  multiplication  of  state  activities,  although  it  was 
particularly  marked  by  the  development  of  state  highways  and 
costly  internal  improvements  such  as  the  new  canal  system  in 
New  York,  by  more  generous  appropriations  for  education,  and 
by  the  multiplication  of  state  commissions.1 

The  student,  and  even  the  general  reader,  will  find  it  especially  instructive 
to  study  the  financial  reports  of  the  federal  government  and  of  our  states  and 
cities,  and  arrange  the  items  of  expenditures  under  various  general  heads. 

1  It  is  exceedingly  difficult  to  arrange  a  classification  that  will  be  at  once  practical 
and  scientific,  i.e.  that  will  show  the  expenditures  of  governmental  departments  as 
they  are  actually  organized,  observe  the  necessary  accounting  distinctions,  and 
answer  scientific  inquiries  of  major  importance.  For  American  classifications  which 
most  nearly  meet  all  the  requirements,  see  the  financial  publications  of  the  Bureau 
of  the  Census;  the  reports  of  the  Comptroller  of  the  State  of  New  York;  the 
Massachusetts  reports  entitled  Statistics  of  Municipal  Finances  ;  and,  for  the  federal 
government,  the  reports  of  the  President's  Commission  on  Economy  and  Efficiency, 
and  in  particular  a  paper  by  Harvey  S.  Chase,  C.P.A.,  dealing  with  the  expenditure 
side  of  the  national  budget,  in  the  American  Economic  Review,  Volume  v,  No.  1, 
Supplement,  pp.  186-195.  A  suggestive  classification  adapted  to  European  condi- 
tions will  be  found  in  Cossa's  Taxation  :  Its  Principles  and  Methods,  Part  ii,  Chapter 
iii.  The  summary  census  classification  printed  on  the  following  page  covers  all 
governmental  subdivisions  in  the  United  States,  except  townships  and  incorporated 
places  having  less  than  2500  inhabitants. 


662 


OUTLINES   OF   ECONOMICS 


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PUBLIC   EXPENDITURES  663 

If  access  can  be  had  to  reports  covering  a  considerable  number  of  years  and 
different  countries,  it  will  be  found  that  an  examination  of  them  will  throw  an 
immense  amount  of  light  upon  the  nature  of  modern  civilization  and  its 
direction. 

It  is  also  instructive  to  compare  expenditures  on  account  of  the  head  of  the 
State  in  various  countries,  and  particularly  to  contrast  monarchical  and 
republican  countries.  It  is  important  to  discover  great  historical  tendencies, 
and  to  contrast  different  periods  of  time,  especially  as  regards  monarchical 
expenditures.  It  is  beyond  all  question  that  relatively,  in  the  civilized 
world,  that  is  an  item  of  declining  importance.  At  the  present  time,  the 
king  of  a  great  country  like  Prussia  or  England  supports  a  magnificence  of 
state  which  is  altogether  out  of  keeping  with  the  ideas  of  a  democracy  or  a 
republic.  Four  or  five  millions  of  dollars  per  annum  for  a  modern  monarch 
is  not  a  large  expenditure.  On  the  other  hand,  in  contrast,  the  expenditures 
of  the  President  of  the  United  States  (including  those  connected  with  the 
executive  mansion,  contingent  expenses  of  all  sorts,  and  presidential  clerks) 
amount  roughly  to  $150,000.  However,  as  regards  the  expenditures  of  a 
modern  monarch  (the  German  Emperor,  for  example),  a  detailed  examina- 
tion shows  that  custom  and  tradition,  as  well  as  the  will  of  the  monarch, 
cause  a  large  part  of  his  income  to  go  for  public  purposes,  and  that  his  wealth 
has  been  largely  socialized.     The  king  is  no  longer  the  typical  rich  man. 

On  the  other  hand,  the  expenditures  on  account  of  the  American  Congress 
are  unprecedented  in  amount  among  the  expenditures  incurred  on  account 
of  legislative  bodies.  The  world  has  never  seen  anything  of  the  kind  be- 
fore, and  nothing  parallel  to  it  can  be  found  in  any  other  country.  Among 
other  things,  this  goes  to  indicate,  as  contrasted  with  Germany,  the  great 
importance  of  the  legislative  body  which  is  supposed  to  represent  the  people 
directly  and  immediately  and  to  carry  out  their  will.  In  aristocratic  coun- 
tries the  legislative  office  is  sometimes  an  unpaid  office.  This  was  until 
recently  the  case  in  British  and  German  parliaments,  the  idea  being  to  favor 
wealth  and  to  counteract  democratic  tendencies  —  an  aim  which  was  not 
accomplished.  A  democracy,  however,  is  more  likely  to  insist  upon  a 
legislative  office  being  a  paid  office;  and,  in  some  of  the  German  states, 
although  the  payment  is  small,  its  acceptance  is  compulsory. 

Expenditures  incurred  in  the  administration  of  foreign  affairs  are  of  in- 
creasing importance  on  account  of  growing  economic  internationalism.  We 
would  here  have  two  main  classes;  namely,  (1)  expenditures  on  account  of 
diplomacy,  those  representing  the  purely  political  side  of  government,  and 
(2)  expenditures  on  account  of  the  consular  service,  representing  the  business 
interests  of  the  country.  Expenditures  connected  with  boundaries  and 
surveys  are  expenses  which  would  come  under  this  general  heading. 

With  regard  to  the  administration  of  foreign  affairs,  any  one  nation  is 
limited  in  what  it  can  do  by  international  customs.  We  Americans,  for 
example,  cannot  force  our  ideas  on  other  nations.     Certain  standards  of 


664  OUTLINES   OF   ECONOMICS 

dignity  and  propriety  have  been  established  with  respect  to  the  mode  of  life 
for  diplomats,  and,  if  we  depart  from  these,  we  do  so  at  a  loss  which  every 
diplomat  in  the  service  of  the  United  States  keenly  feels.  The  most  that  we 
can  do  is  to  exercise  pressure  in  what  we  believe  to  be  the  right  direction, 
and  that  is  the  direction  of  democratic  simplicity. 

When  we  examine  expenses  incurred  in  the  administration  of  justice,  we 
notice  a  large  increase  with  the  growth  of  democracy.  In  earlier  times  in 
countries  like  England  and  Germany/  the  administration  of  justice  was  to  a 
greater  or  less  extent  "patrimonial,''  being  connected  with  certain  estates. 
The  duty  of  administering  justice  went  with  the  great  estate  or  manor  and 
involved  little  expense.  As  people  take  things  into  their  own  hands  they 
must  pay  their  own  expenses.  Democracy,  in  its  progress,  means  large 
public  expenditures. 

The  new  humanitarianism  of  the  age,  which,  in  a  way,  is  one  expression  of 
democracy,  involves  large  expenditures,  as  seen  in  education,  modern  re- 
formatories, etc.  But  it  is  believed  by  the  advocates  of  humanitarianism  and 
democracy  that  these  expenditures  are  worth  while. 

It  is  when  we  come  to  expenses  incurred  in  the  promotion  of  the  general 
welfare  that  we  see  the  most  remarkable  and  encouraging  phenomena  that 
greet  us  in  the  treatment  of  public  expenditures.  This  has  been  seen  in  the 
data  already  given,  and  will  become  increasingly  manifest  as  the  student 
carries  on  his  statistical  studies  in  this  field. 

QUESTIONS 

i.  Define  public  finance.  Why  should  it  be  regarded  as  a  part  of  eco- 
nomics? Can  you  give  any  reasons  why  it  should  be  regarded  as  a  sepa- 
rate science? 

2.  Can  we  spare  money  for  taxes  only  when  we  have  an  income  affording 
a  surplus  over  and  above  necessities?  If  the  money  paid  for  taxes  is  used  to 
provide  us  with  necessities,  is  there  any  good  ground  for  the  doctrine  that  an 
income  sufficient  to  afford  a  minimum  of  subsistence  should  be  exempted 
from  taxation  in  the  case  of  an  income  tax? 

3.  What  various  meanings  do  you  ascribe  to  the  enormous  increase  in 
public  expenditures  during  the  nineteenth  century? 

4.  What  should  be  the  consequences  if  the  government  of  the  state  in 
which  you  live  should  strive  for  the  largest  possible  amount  of  revenue,  and 
then  govern  its  expenditures  so  as  to  consume  the  entire  state  income? 

5.  Discuss  the  differences  between  public  expenditures  and  the  expendi- 
tures of  a  private  household.  Would  you  regard  it  wise  on  your  part  to 
make  any  expenditures  with  the  idea  that  a  benefit  to  some  one  would  accrue 
one  hundred  years  later?  fifty  years  later?  twenty  years  later? 

6.  What  considerations  must  govern  us  when  we  attempt  to  answer  the 
question,  "What  is  the  proper  proportion  between  public  expenditures  and 
the  total  income  of  society?" 


PUBLIC   EXPENDITURES  665 

7.  Discuss  Wagner's  rule.  Is  the  fact  that  public  ownership  increases 
the  permissible  proportion  of  social  income  that  may  be  used  for  public 
purposes  an  argument  for  public  ownership  of  railways?  If  so,  why?  If 
not,  why  not? 

8.  Discuss  economy,  parsimony,  frugality,  extravagance  in  public  ex- 
penditures, and  give  as  full  illustrations  of  each  as  you  are  able  (a)  from  your 
own  observation,  (b)  from  your  reading  and  conversation  and  correspondence 
with  others,  public  officials  included. 

9.  Discuss  the  historical  order  in  which  items  of  expenditure  appear  in 
national,  state,  and  local  governments.  Give  illustrations  from  the  state  and 
from  the  local  political  unit  in  which  you  live.  Give  any  illustration  which 
may  occur  to  you  of  taxation  which  lightens  the  burdens  of  the  taxpayer. 

10.  If  you  were  permanent  Secretary  of  War,  would  you  desire  to  know  for 
a  long  number  of  years  in  advance  the  yearly  sums  that  could  be  expended 
on  the  army?  Could  you  thus  make  the  same  amount  of  money  accomplish 
more  than  if  dependent  upon  annual  grants  uncertain  in  amount?  What 
would  be  your  view  as  a  member  of  Congress?  Is  a  state  university  to  be 
controlled  in  its  expenditures  by  the  legislature  as  rigidly  as  Congress  should 
control  the  administration  of  the  army?  If  so,  why?  If  not,  why  not? 
Would  you  make  any  distinction  in  this  respect  between  the  army  and  the 
navy  ? 

1 1 .  Present  such  statistics  as  you  may  be  able  to  gather  showing  relatively 
and  for  as  long  a  time  as  possible  the  increases  in  public  expenditures  in  the 
federal  government,  in  your  own  state,  and  in  your  own  local  political  unit 
(city,  county,  town,  etc.),  and  give  all  the  evidence  that  you  can  secure  show- 
ing the  significance  of  the  movement. 

REFERENCES 

Government  publications  generally. 

As  illustrative  particularly  of  the  expansion  of  government  expenditures  and 
public  work,  the  Year  Book  of  the  Department  of  Agriculture. 

For  growth  of  militarism,  take  publications  of  the  Department  of  War  and 
publications  of  similar  departments  in  other  countries. 

For  general  statistical  data,  the  Statesman's  Year  Book  is  as  reliable  as  any- 
thing in  English.  For  our  own  country,  see  annual  Finance  Report  of 
the  Secretary  of  the  Treasury,  and  census  reports,  especially  the  reports 
on  Wealth,  Debt,  and  Taxation.  For  making  a  broad  survey  of  the  federal 
expenditures  of  the  United  States,  perhaps  no  single  publication  is  more 
useful  than  the  annual  Letter  from  the  Secretary  of  the  Treasury  trans- 
mitting Estimates  of  Appropriations.  A  striking  exhibit  of  the  growth 
of  federal  expenditures  will  be  found  in  Senate  Document  No.  528,  60th 
Congress,  1st  Session,  entitled  Expenditures  of  the  United  States  Govern- 
ment, 1791-1907. 


CHAPTER  XXXII 

PUBLIC  RECEIPTS  FROM  LOANS  AND  GOVERNMENT 
OWNERSHIP 

Public  Debts.  —  The  modern  State  follows  a  policy  of  deficit 
financiering.  The  great  and  increasing  expenditures,  which 
have  been  described  in  the  preceding  chapter,  entail  burdens 
too  heavy  to  be  borne,  at  least  in  the  first  instance,  by  taxation 
alone,  and  recourse  must  constantly  be  had  to  the  public  credit. 
Even  before  the  European  War,  about  one  fourth  of  the  annual 
revenue  of  England  was  used  in  the  payment  of  debt  or  in- 
terest upon  debt ;  and,  as  is  shown  in  the  French  budgets  given 
on  page  659,  more  than  one  fourth  of  the  total  expenditures  of 
France  was  devoted  to  the  same  purpose. 

In  the  last  half  of  the  nineteenth  century,  the  aggregate  pub- 
lic debt  of  the  civilized  world  increased  enormously.  According 
to  the  best  estimates,  the  indebtedness  of  the  national  govern- 
ments of  the  world,  which  amounted  to  $7,627,700,000  in  1848, 
had  risen  to  $27,525,000,000  in  1890,  and  since  that  time  it  has 
greatly  increased.  Figures  showing  the  total  and  per  capita 
debt  of  all  governmental  divisions  of  this  country  are  given  in 
Table  I.  From  this  statement  it  appears  that  between  1902 
and  1913  the  aggregate  public  debt  of  this  country  increased 
by  over  $2,000,000,000,  the  greater  part  of  the  increase  being 
ascribable  to  the  astonishing  growth  of  municipal  and  local  in- 
debtedness, which  increased  by  113  per  cent  in  the  interval.  It 
is  true  that  the  total  public  debt  is  less  than  it  was  in  1870,  that 
the  per  capita  debt  has  fallen  from  $82.99  m  ^70  to  $49.97  in 
1913,  and  that  according  to  Census  estimates  of  national  wealth 
(not  very  trustworthy),  the  public  debt  covered  only  $2.58  of 
each  one  hundred  dollars  of  national  wealth  in  1912,  as  against 
$2.85  in  1902,  $3.06  in  1890,  $6.97  in  1880,  and  $10.64  in  1870. 

C66 


PUBLIC   RECEIPTS 


667 


But  this  diminution  of  the  aggregate  debt  is  due  to  the  extraor- 
dinary progress  which  our  tariff  surpluses  have  enabled  us  to 
make  in  reducing  the  debt  contracted  during  the  Civil  War; 
and  the  normal  movement  in  the  long  run  is  probably  toward  an 
increase  of  the  public  debt,  at  least  absolutely  and  per  capita, 
if  not  in  proportion  to  the  national  wealth.1 


TABLE   I 

Public  Debt  of  the  United  States 

(Debt  less  sinking  fund  assets) 

Total  in  Millions  of  Dollars 

Per  Capita 

*9*3 

1902 

1890 

1880 

1870 

1913 

1902 

1890 

1880 

1870 

Total    .... 

$4850 

$2839 

$1989 

$3043 

$3200 

$49-97 

$35-99 

$3L76 

$60.66 

$82.99 

National  gov't  . 

1029 

969 

852 

1919 

2331 

10.59 

12.22 

13.60 

38.27 

60.46 

States  .... 

340 

239 

211 

275 

353 

3-57 

3-03 

3-37 

5-48 

9-15 

Minor  divisions 

3476 

1630 

926 

849 

5i6 

35-8i 

20.74 

14.79 

16.91 

13.38 

The  great  increase  of  public  debts  is  due  principally  to  two 
causes,  wars  and  public  works.  The  former  are  misfortunes, 
losses,  however  the  result  is  expressed.  The  loss  comes,  not  in 
contracting  a  debt,  but  in  spending  and  destroying  the  property 
consumed  by  war.  This  loss  cannot  be  postponed  by  a  debt, 
although  one  nation  may  postpone  part  of  the  loss  by  borrow- 
ing goods  and  supplies  from  the  people  of  another  nation.  It 
comes  out  of  wealth  existing  or  produced  at  the  time,  no  matter 
what  arrangement  is  made.  In  former  times  each  man  bore 
the  loss  as  it  happened  to  fall  on  him.  The  modern  method 
differs  in  just  this,  that  the  loss  is  transferred  to  the  whole 
public.  This,  again,  may  be  done  in  two  ways.  A  tax  may 
be  levied  at  the  time  sufficient  to  pay  all  expenses,  or  a  debt  may 

1  According  to  Census  estimates,  the  per  capita  debt  of  the  United  Kingdom  in 
1904-"! 905  was  3.93,  that  of  France  4.86,  and  that  of  Italy  2.25  times  as  great  as  the 
per  capita  debt  of  the  United  States  in  1902,  while  that  of  Sweden  was  a  trifle  less 
than  the  per  capita  debt  of  the  United  States. 


668  OUTLINES  OF  ECONOMICS 

be  incurred  and  the  necessary  taxation  spread  over  a  longer 
period  of  time.  In  practice  the  latter  proves  far  the  best,  for 
at  least  a  part  of  the  expenses.  It  gives  taxpayers  time  to 
adjust  themselves  to  the  extraordinary  demands.  A  war  debt 
is,  therefore,  not  a  misfortune,  though  it  stands  for  a  previous 
misfortune  —  war. 

The  case  is  clearer  when  we  consider  debts  contracted  for 
public  works.  Under  this  head  we  include  primarily  productive 
enterprises  like  railways,  canals,  forests,  gas  works.  These, 
when  purchased  or  constructed  by  the  government,  are  the  occa- 
sion of  debts,  sometimes  enormous  in  amount.  It  might  seem 
possible  to  pay  for  them  by  immediate  and  heavy  taxation, 
since  no  more  is  taken  out  of  the  people  than  when  the  money  is 
borrowed.  But  the  national  wealth  is  not  like  an  ocean,  alike 
in  all  its  parts  and  instantly  filling  up  where  water  is  dipped  out. 
It  makes  all  the  difference  in  the  world  where  you  dip.  Here 
are  men  who  have  funds  invested  in  a  productive  business; 
here  are  others  who  have  funds  lying  idle.  The  State  decides 
to  make  a  public  investment,  and  calls  for  money.  If  it  col- 
lects it  by  an  immediate  and  heavy  tax,  the  first  class  have  a 
part  of  their  ordinary  earnings  withdrawn,  and  their  business  is 
crippled  or  ruined.  The  others  have  some  of  their  funds  with- 
drawn, but  the  most  still  lies  idle.  The  best  that  can  be  done 
in  such  a  case  is  for  the  first  class  to  borrow  of  the  second, 
which  only  makes  private  debts  instead  of  public  ones  —  a 
much  more  burdensome  condition  of  things  for  the  national  in- 
dustry. The  wiser  modern  method  is  for  the  State  to  borrow 
the  unemployed  funds  and  leave  industrial  operations  intact, 
then  imposing  a  moderate  tax  which  can  be  paid  out  of  annual 
income.  If  the  expenditure  in  question  is  an  investment,  it  pre- 
sumably pays  for  itself  in  time  without  requiring  taxation. 

This  brings  us  to  the  relation  between  taxes  and  debts.  Taxes 
should  never  be  so  heavy  that  they  cannot  be  paid  easily  out  of 
annual  income.  If  they  trench  upon  national  savings,  they  de- 
range private  industries  disastrously  because  they  are  imposed 
upon  all  without  regard  to  the  nature  of  their  investments. 
But  while  taxes  cannot  safely  exceed  the  national  disposable 


PUBLIC   RECEIPTS  669 

surplus  for  each  year,  it  does  not  follow  that  the  State  may  not 
take  savings  as  well  as  surplus  for  its  undertakings ;  only  these 
savings  must  be  taken  from  those  who  have  uninvested  savings. 
This  cannot  be  done  by  any  method  of  general  contribution 
like  taxation.  It  can  only  be  done  by  public  loans.  Whether 
the  loan  is  a  wise  thing  or  not  depends  altogether  on  the  nature 
of  the  State's  investment.  If  the  State  takes  these  savings  ever 
so  wisely  and  wastes  it,  the  people  have  lost  just  so  much  capi- 
tal. If,  on  the  other  hand,  the  State  takes  savings  which  were 
uninvested  and  therefore  unproductive,  and  invests  them  in  a 
profitable  undertaking,  the  net  result  to  society  is  an  additional 
profit.  Public  debts  are  no  indication  of  national  poverty. 
Whether  a  nation  is  growing  poorer  or  richer  depends  not  on  its 
indebtedness,  but  on  its  production  relatively  to  its  consump- 
tion. Public  debts  are  not  a  good  thing  in  and  of  them- 
selves, but  they  have  incidental  advantages  which  offset  some 
of  their  disadvantages. 

Having  noticed  the  natural  limits  of  both  taxation  and  borrow- 
ing, we  have  now  to  ask,  What  kind  of  expenditures  should  be 
provided  for  by  each?  In  general  the  answer  is  easy,  though 
details  are  troublesome  at  times.  Ordinary  expenditures,  that 
is,  those  which  recur  with  sufficient  regularity  so  that  they  can 
be  foreseen  and  estimated  in  advance,  if  not  provided  for  by 
receipts  from  domains  and  industries,  should  be  met  by  taxa- 
tion. If  the  State  cannot  do  this,  it  is  a  confession  that  ordi- 
nary expenditures  are  in  excess  of  the  disposable  surplus  income 
of  the  nation,  a  state  of  things  which  means  bankruptcy  if  con- 
tinued long  enough. 

Extraordinary  expenditures,  caused  by  national  calamities, 
such  as  floods  or  war,  and  public  investments  —  railways, 
city  gas  works,  etc.  —  may  be  met  by  loans.  The  function  of 
loans  thus  becomes  a  double  one  :  first,  the  distribution  of  un- 
avoidable losses,  so  that  industry  is  as  little  disturbed  as  pos- 
sible ;  and  second,  the  investment  of  uninvested  capital  in 
productive  public  enterprises. 

In  the  creation  and  management  of  public  debt  it  is  pecul- 
iarly necessary  to  observe  the  golden  mean  and   avoid  both 


670  OUTLINES  OF  ECONOMICS 

improvidence  and  unwise  restrictions.  Obviously,  temporary 
deficits  resulting  from  a  failure  of  current  revenue  to  meet  cur- 
rent expenses,  should  not  be  allowed  to  accumulate  and  then 
be  funded  as  a  permanent  debt.  This  is  a  vice  of  boss-ridden 
government  which  goes  far  to  explain  the  rapid  growth  of  Ameri- 
can municipal  indebtedness  in  the  last  half  of  the  nineteenth 
century.  Similarly,  in  our  opinion,  debt  should  not  be  con- 
tracted in  order  to  erect  public  schools  or  other  durable  improve- 
ments which,  although  capable  of  rendering  service  through  a 
long  period  of  years,  produce  no  money  revenue  and  represent 
from  the  fiscal  standpoint  continuing  liabilities  rather  than 
durable  assets.  It  must  be  admitted  that  authorities  differ  on 
this  point ;  but  even  among  those  who  sanction  the  contracting 
of  debt  to  pay  for  durable  improvements  which  are  financially 
non-productive,  it  is  agreed  that  in  any  event  the  life  of  the 
debt  should  not  exceed  the  life  of  the  improvement  in  question. 
Long-time  bonds,  for  instance,  should  not  be  employed  to  resur- 
face roads  and  pay  for  highway  improvements  which  will  last 
only  a  few  years.  Finally,  in  our  opinion,  restriction  may  be 
properly  imposed  upon  public  indebtedness  contracted  for  pur- 
poses which  are  fiscally  nonproductive,  although  such  restric- 
tions should  limit  the  increase  of  indebtedness  and,  for  reasons 
which  have  been  stated  on  page  653,  should  not  be  expressed 
as  a  percentage  of  the  assessed  valuation  of  taxable  property. 

On  the  other  hand,  few,  if  any,  restrictions  should  be  placed 
upon  borrowing  for  the  purpose  of  acquiring  income-yielding 
property.  Such  restrictions  place  states  and  cities  at  a  dis- 
advantage as  compared  with  private  corporations.  They  also 
ope  ate  to  throw  into  the  hands  of  private  corporations  enter- 
prises which  cannot  be  paid  for  out  of  one  year's  revenue,  and 
yet  might  advantageously  be  acquired  by  the  public.  At  the 
present  time  excessive  limitations,  unworthy  of  a  free  people, 
make  it  impossible  for  some  cities  to  carry  out  necessary  public 
improvements  which  would  not  impose  the  slightest  real  burden 
upon  taxpayers.  In  Chicago,  several  years  ago,  after  a  pro- 
longed and  exceedingly  expensive  campaign  for  the  improve- 
ment of  the  street  car  service,  the  city  was  prevented  from  carry- 


PUBLIC   RECEIPTS  671 

ing  out  a  carefully  devised  plan  of  reform  by  a  court  decision 
which  held  that  an  issue  of  street  railway  ceriificates  would  in- 
crease the  indebtedness  of  the  city  beyond  the  limits  prescribed 
by  the  constitution.  Rigid  limitations  which  prevent  munici- 
palities from  offsetting  part  of  their  debt  by  the  value  of  water- 
works, lighting  plants,  and  other  assets  which  yield  a  monetary 
return,  have  no  place  in  a  scientific  system  of  public  finance. 

While  not  absolutely  required  by  theory,  it  is  probably  desir- 
able as  a  matter  of  practical  political  psychology  to  make  pro- 
vision for  the  extinction  of  all  public  debts  within  a  period,  say, 
of  sixty  years.  It  has  been  customary  in  the  past  to  do  this 
by  means  of  sinking  funds,  but  experience  has  shown  that  the 
sinking  fund  is  a  cumbersome,  wasteful,  and  unscientific  method 
of  accomplishing  the  desired  end.  Bonds  which  automatically 
mature  in  recurring  installments  offer  a  much  better  device  for 
the  retirement  of  public  debts.  The  serial  bond,  as  such  an 
obligation  is  called,  "  can  usually  be  placed  at  a  lower  rate  of 
interest  than  a  sinking  fund  obligation.  It  is  free  from  most 
of  the  possibilities  of  political  abuse  and  manipulation  to  which 
sinking  funds  are  exposed.  It  substitutes  a  plain  and  certain 
for  an  uncertain  or  complicated  liability;  and  it  compels  the 
administration  which  contracted  the  debt  to  begin  its  retire- 
ment immediately." * 

The  Public  Domain.  —  By  domains  we  usually  mean  agricul- 
tural and  mineral  land  and  forests  owned  by  the  State  and  man- 
aged in  the  interest  of  the  public  revenue,  although  we  might 
logically  subsume  under  the  term  the  streets  and  other  public 
property  of  cities,  with  all  the  valuable  franchises  and  privileges 
which  go  with  them.  The  direct  revenue  from  this  source  in 
the  United  States  is  not  large,  and  if  account  be  taken  of  the 
cost  of  the  public  domain  and  the  expense  which  it  has  entailed, 
the  net  earnings  would  possibly  be  a  minus  quantity. 

Until  a  comparatively  recent  date  this  was  not  the  case.  In 
early  feudal  times  the  king  had  large  estates  of  his  own  from 
the  produce  of  which  the  government  was  largely  supported, 

1  Report  of  the  Committee  on  Increase  of  Public  Expenditures,  Proceedings  oj 
the.  National  Tax  Association,  vol.  ix,  p.  465. 


672  OUTLINES  OF   ECONOMICS 

and  although  he  had  certain  military  rights  over  his  subjects,  he 
had  very  limited  rights  over  their  property.  Later,  the  king 
became  a  public  rather  than  a  private  person,  and  a  large  part  of 
the  crown  estate  became  the  property  of  the  public ;  but  even 
then  taxation  was  relatively  unimportant,  and  the  State  relied 
principally  ir  times  of  peace  upon  fines,  escheats,  fees,  crown 
prerogatives  (certain  dues  which  the  king  was  entitled  to  col- 
lect as  of  his  own  right),  and  upon  the  proceeds  of  the  public 
domain.  Blackstone,  the  great  English  jurist,  writing  in  1765, 
classified  taxation  among  the  "  extraordinary  "  revenues  of  the 
sovereign ;  and  in  some  of  the  German  principalities  the  govern- 
ment was  enabled  to  get  along  without  taxation  in  times  of 
peace,  down  to  the  close  of  the  eighteenth  century.  Real 
democracy  not  yet  having  been  achieved,  the  people  distrusted 
taxation  and  resented  its  imposition,  while  the  sovereign  wisely 
clung  to  that  species  of  revenue  which  was  independent  of  the 
people's  caprice.  "  The  public  domains,"  said  Bodin,  the  great 
political  philosopher  of  France  in  the  latter  part  of  the  sixteenth 
century,  "  should  be  holy,  sacred,  and  inalienable  either  by 
grant  or  by  prescription." 

But  as  democracy  developed  and  the  representatives  of  the 
people  gained  control  of  the  finances,  a  new  policy  was  every- 
where adopted.  If  State  management  was  uneconomical  and 
wasteful,  and  if  the  government  could  obtain  all  the  revenue 
needed  by  taxation,  why  preserve  the  wasteful  methods  of 
management?  Why  not  turn  public  property  into  private 
property,  to  be  developed  and  multiplied  through  the  vitaliz- 
ing force  of  individual  self-interest  ?  The  great  truth  was  real- 
ized that  the  property  of  individuals,  when  subject  to  taxation  and 
regulation,  is  no  less  part  of  the  great  patrimony  of  the  State  than 
those  lands  and  forests  whose  title  is  retained  by  the  government 
itself.  This  doctrine  was  generally  accepted  by  the  greater 
countries  of  the  world  during  the  eighteenth  century,  so  that 
Adam  Smith,  in  defending  it  in  1776,  was  able  to  write  that 
"  there  is  not  at  present,  in  Europe,  any  civilized  state  of  any 
kind  which  derives  the  greater  part  of  its  public  revenue  from 
the  rent  of  lands  which  are  the  property  of  the  state."     This 


PUBLIC   RECEIPTS  673 

philosophy  was  dominant  when  our  national  government  was 
created  in  1789,  and  has  guided  our  national  policy  ever  since. 
Land  Policy  of  the  United  States.  —  By  exploration  and  occu- 
pancy, war,  and  various  cessions,  the  federal  government  ac- 
quired, after  the  Revolutionary  War,  a  magnificent  domain  of 
2,252,244  square  miles.  Now,  while  we  have  consistently  fol- 
lowed the  doctrine  of  alienation  until  very  recent  years,  trying, 
apparently,  to  get  rid  of  the  public  domain  as  rapidly  as  possible, 
one  observes  historically  a  very  important  change  in  the  manner 
of  development.  In  the  early  years  of  the  Republic,  large 
revenues  were  expected  from  the  sale  of  public  lands ;  it  was 
the  financial  side  which,  according  to  Alexander  Hamilton, 
claimed  "  primary  attention."  1  Until  about  1800,  the  policy 
was  to  sell  the  land  in  large  blocks,  even  though  it  went  to 
speculators ;  this  was  followed  by  an  attempt  to  sell  small  hold- 
ings to  actual  settlers,  the  credit  system  being  used  with  dis- 
astrous results;  later  (1830),  the  preemption  policy  was  intro- 
duced by  which  bona  fide  home  makers  were  given  certain  ad- 
vantages in  purchase ;  and  finally  came  the  Homestead  Act  of 
1862,  the  Timber  Culture  Act  of  1873  (now  repealed),  and  the 
other  less  important  laws  by  which  actual  settlers  can  obtain 
homes  practically  free  of  cost.  From  the  very  beginning  we 
have  used  our  public  lands  as  bounties,  to  hasten  the  develop- 
ment of  the  country ;  and  this  policy  has  been  carried  out  by 
enormous  grants  of  land  for  the  endowment  of  education  and 
the  subsidization  of  canal,  railway,  and  other  internal  improve- 
ment companies.  Our  original  aim,  however,  was  not  only  to 
develop  the  country  as  rapidly  as  possible,  but  to  secure  as  much 
revenue  as  possible  from  the  sale  of  public  lands.  We  still  aim 
to  develop  the  country,  but  the  idea  of  profit  has  been  replaced 
by  the  policy  of  giving  land  to  the  landless.  To  exaggerate  the 
evolution  of  policy  for  the  sake  of  emphasis,  it  may  be  said  that 
we  began  with  a  productive  policy,  and  modified  it  with  a  dis- 
tributive policy ;  that  in  the  beginning  our  object  was  the 
greatest  good,  while  now  it  is  the  greatest  good  to  the  greatest 
number,  or,  in  terms  more  appropriate  to  the  exact  case  in  hand, 

1  Quoted  by  Donaldson,  The  Public  Domain,  p.  iq8. 


674  OUTLINES  OF  ECONOMICS 

the  greatest  possible  use  of  the  public  domain  consistent  with 
widespread  participation  in  that  use. 

Forest  Lands.  —  The  policy  of  alienation,  while  on  the  whole 
sound,  is  subject  to  certain  limitations  which  it  is  very  important 
to  note.  First  of  these  is  the  case  of  forests.  The  ruthless  de- 
nudation of  our  timber  lands,  the  striking  advance  in  the  price 
of  lumber  indicating  that  the  supply  has  not  kept  pace  with  the 
demand,  and  the  meteoric  development  and  rapid  decline  of  the 
lumber  industry  in  many  localities  of  the  Northwest,  all  com- 
bine to  demonstrate  that  alienation  and  private  ownership  have 
failed  to  produce  that  careful  industrial  management  which 
conduces  to  the  greatest  use  and  the  greatest  good  in  the  long 
run.  More  important  still,  we  have  come  to  realize  that  the 
most  productive  use  of  other  great  natural  resources  has  not 
been  subserved  by  the  private  ownership  of  the  forests.  The 
regular  flow  of  streams,  the  success  of  the  great  irrigation  works 
which  we  are  building,  and  the  proper  development  of  our  mines, 
all  depend  more  or  less  upon  the  permanent  preservation  of  our 
forests ;  but  private  ownership  and  management  in  the  past  has 
led  to  destruction,  not  preservation. 

The  United  States  awoke  very  slowly  to  these  truths.  Prussia 
abandoned  the  policy  of  disposing  of  forest  lands  in  1831. 
France  and  Austria  began  to  increase  their  forest  holdings  about 
1870.  But  in  the  United  States  it  was  not  until  1876  that  an 
awakened  interest  showed  itself  in  a  congressional  appropriation 
of  two  thousand  dollars  for  the  purpose  of  employing  "  a  com- 
petent man  to  investigate  timber  conditions  in  the  United 
States."  In  1881  a  Division  of  Forestry  was  created  in  the  De- 
partment of  Agriculture.  This  expanded  into  the  Bureau  of 
Forestry  in  1901,  and  into  the  Forest  Service  in  1905.  In  1891 
a  forward  step  was  taken  by  the  passage  of  an  act  authorizing 
the  President  to  establish  forest  reserves;  and  in  the  same 
year  the  first  forest  reserve  was  established.  In  March,  1915, 
the  area  of  the  national  forest  reserves  had  increased  to 
184,611,596  acres  (of  which  21,337,533  were  privately  owned); 
the  forest  service  had  developed  to  a  point  where  it  was  able  to 
care  for  the  management  of  this  vast  national  industry,  and  to 


PUBLIC   RECEIPTS  675 

cooperate  further  with  private  owners  in  establishing  the  prin- 
ciples of  scientific  forestry,  while  the  policy  of  alienation  has  been 
modified  to  an  extent  amounting  almost  to  reversal.  Instead  of 
selling  forests,  the  government  is  now  permitting  timber  to  be 
cut  in  a  way  to  preserve  the  forests.  The  revenue  from  this 
source  at  the  present  time  is  nearly  $2,500,000,  but  that  is  a 
secondary  consideration.  The  important  point  is  that  the 
government  has  demonstrated  its  ability  to  manage  the  forests 
along  lines  at  once  scientific  and  commercial.  In  many  Euro- 
pean countries,  however,  a  greater  revenue  is  secured  from  the 
forests.  In  France,  for  example,  the  public  forests  cover  nearly 
18  per  cent  of  the  entire  land  surface  of  the  country,  and  yield 
approximately,  it  is  reported,  $2.50  per  acre  annually,  —  giving 
a  revenue  of  about  $59,000,000  a  year.  In  the  United  States 
at  present  35  per  cent  of  what  is  received,  according  to  law,  goes 
to  the  states  and  territories  in  which  the  reserves  are  situated 
for  public  roads  and  schools.  It  is  estimated  that  in  a  few 
years  the  reserves  will  yield  not  less  than  $5,000,000  a  year. 

Experience  seems  to  show  that  the  public  ownership  and 
management  of  forests  is  more  efficient  than  private  ownership 
and  management.  This  is  due  to  the  length  of  time  required  to 
realize  upon  investments  in  this  industry,  its  routine  character, 
the  large  area  one  man  can  supervise,  and,  perhaps  chiefly,  to 
the  fact  that  the  government  in  its  management  takes  into  ac- 
count the  interests  of  the  community  as  a  whole.  Although 
private  corporations  may  make  plans  for  a  long  period  of  time, 
they  are  less  desirable  owners  and  managers,  especially  in  the 
last  particular.  The  property  tax,  as  now  levied,  is  one  of  the 
greatest  enemies  of  rational  forestry  by  private  owners.  If  an 
owner  is  forced  to  pay  ordinary  property  taxes  upon  a  stand- 
ing or  growing  forest  year  after  year,  the  pressure  to  cut  the 
timber  is  almost  irresistible.  The  State  spends  millions  of  dol- 
lars to  preserve  the  forests,  and  yet  often  enforces  a  tax  that 
puts  a  premium  upon  their  destruction. 

Mineral  Lands.  —  Our  experience  with  timber  lands  is  im- 
portant as  showing  that  private  ownership  of  some  kinds  of 
land  has  not  resulted  in  the  greatest  or  wisest  use  of  that  land. 


676  OUTLINES   OF   ECONOMICS 

Our  experience  with  mineral  lands  demonstrates  that  the  policy 
of  disposing  of  public  lands  in  small  holdings,  free  of  cost  or  at 
prices  far  below  their  real  value,  has  not  led  to  a  widespread 
participation  in  the  use  and  profit  of  those  lands.  The  reason 
for  this,  broadly  speaking,  is  that  our  policy  of  alienation  in 
small  holdings  conflicts  with  the  requirements  and  necessities  of 
modern  industry.  In  disposing  of  our  lands  we  have  tried  to 
balk  the  corporation  and  the  speculator  in  order  to  subsidize  the 
settler  and  home  builder.  For  instance,  we  have  made  the  recip- 
ients of  homesteads  and  mineral  claims  swear  that  they  are  not 
acting  as  agents  "for  any  person,  corporation,  or  syndicate,"  or 
"  in  collusion  with  any  person,  corporation,  or  syndicate,  to  give 
them  the  benefit  of  the  land  entered,"  and  that  the  land  is  not 
being  secured  "  for  the  purpose  of  speculation."  Yet  for  pur- 
poses of  grazing  and  in  less  degree  for  mining  and  lumbering, 
modern  industrial  methods  require  that  large  tracts  of  land 
shall  be  worked  together,  and  that  individual  claims  shall  be 
consolidated.  The  core  of  the  difficulty  was  well  described 
by  Mr.  Roosevelt,  when  President,  in  these  words :  "  It  is  a 
scandal  to  maintain  laws  which  sound  well  but  which  make 
fraud  the  key  without  which  great  natural  resources  must  re- 
main closed.  The  law  should  give  individuals  and  corporations, 
under  proper  government  regulation  and  control,  the  right  to 
work  bodies  of  coal  lands  large  enough  for  protfiable  develop- 
ment." And  he  thereafter  recommended  laws  to  authorize  the 
leasing,  instead  of  the  complete  alienation,  of  coal,  oil,  and  gas 
rights,  as  well  as  grazing  rights  on  the  public  domain.  Already 
the  royalty  has  been  adopted  by  some  of  the  state  governments, 
and  has  been  employed  in  a  few  of  the  permits  issued  by  the 
federal  departments  of  Agriculture  and  the  Interior.1  In  a 
few  decades,  these  leases  will  probably  yield  handsome  revenues 
in  some  of  the  western  states  which  have  adopted  them.  As 
time  passes  the  federal  government  exercises  more  freely  its 
powers  of  reserving  mineral  rights  in  lands  granted  to  "  home- 

1  Cf.  the  conditions  of  the  interesting  permit  issued  in  favor  of  the  International 
Power  and  Manufacturing  Company,  and  published  as  Senate  Document  No  147, 
63d  Cong.,  1st  Sess. 


PUBLIC    RECEIPTS  677 

steaders  "  or  municipalities,  and  of  withdrawing  from  entry 
valuable  mineral  deposits  such  as  the  potash  beds  of  California. 
Year  by  year,  therefore,  the  policy  of  complete  alienation  is 
more  and  more  restricted. 

The  Success  of  our  Land  Policy.  —  In  a  rough,  general  way, 
our  land  policy  has  been  a  success,  as  is  shown  by  the  unprece- 
dented and  almost  feverish  development  of  the  country  in  the 
last  century,  with  the  creation  of  a  fund  of  taxable  values  which 
makes  it  an  easy  matter  for  the  state  governments  to  raise  all 
the  revenue  which  they  need.  But  in  some  respects  it  has 
signally  failed.  In  the  first  place  it  has  not  paid  :  more  money 
has  been  spent  for  the  purchase,  survey,  and  care  of  the  public 
lands  than  has  been  received  from  their  sale  and  lease.  In  the 
second  place,  certain  kinds  of  lands,  as  we  have  shown,  should 
not  have  been  alienated.  And  in  the  third  place,  our  efforts  to 
give  land  to  the  landless  have  bred  an  immense  amount  of  cor- 
ruption, fostered  speculation,  endowed  private  monopoly  with 
public  wealth,  and  pauperized  whole  communities.  One  has 
only  to  recall  the  convictions  of  public  officers  for  land  frauds, 
and  to  read  the  report  of  the  Public  Lands  Commission  —  to 
which  specific  reference  is  given  at  the  end  of  the  chapter  -  -  to 
appreciate  the  truth  of  all  these  charges.  The  desert  land  law 
and  the  commutation  clause  of  the  Homestead  Act,  they  tell 
us,  operate  far  too  often  "  to  bring  about  land  monopoly  rather 
than  to  multiply  small  holdings  by  actual  settlers."  ...  "In 
many  localities,  and  perhaps  in  general,  a  larger  proportion  of 
the  public  land  is  passing  into  the  hands  of  speculators  and  cor- 
porations than  into  those  of  actual  settlers  who  are  making 
homes."  ...  "  Nearly  everywhere  the  large  landowner  has 
succeeded  in  monopolizing  the  best  tracts,  whether  of  timber  or 
of  agricultural  land."  .  .  .  "  Your  commission  has  had  inquiries 
made  as  to  how  a  number  of  estates,  selected  haphazard,  have 
been  acquired.  Almost  without  exception,  collusion  or  evasion 
of  the  letter  and  spirit  of  the  land  laws  was  involved."  .  .  . 
"  The  fundamental  fact  that  characterizes  the  present  situation 
is  this :  that  the  number  of  patents  issued  is  increasing  out  of 
all  proportion  to  the  number  of  new  homes." 


678  OUTLINES  OF  ECONOMICS 

Possibly  the  most  important  lesson  to  be  derived  from  the  his- 
tory of  our  landed  domain  is  the  vital  truth  that  the  government 
cannot  give  away  valuable  lands  or  sell  them  at  prices  far  below 
their  real  value  without  subsidizing  the  speculator,  endowing 
monopoly,  and  pauperizing  the  people.  The  poorer  classes  de- 
rive no  real  benefit  from  this  indiscriminate  public  charity.  As 
Secretary  of  the  Interior  Hitchcock  said  in  1905,  in  discussing 
the  Timber  and  Stone  Act : *  "  Many  transfers  of  land  patented 
under  this  law  are  made  immediately  upon  completion  of  title  to 
individuals  and  companies.  In  this  way  a  monopoly  of  the  tim- 
ber supplies  of  the  public-land  states  is  being  created  by  sys- 
tematic collusion.  ...  It  has  been  urged  in  behalf  of  this  act 
that  it  enables  poor  men  to  enjoy  the  bounty  of  the  government 
by  obtaining  tracts  of  land  which  they  can  afterwards  sell  with 
advantage.  A  careful  study  seems  to  show,  on  the  contrary, 
that  the  original  entrymen  rarely  realize  more  than  ordinary 
wages  for  the  time  spent  in  making  the  entry  and  completing 
the  transfer.  The  corporations  which  ultimately  secure  title 
usually  absorb  by  far  the  greater  part  of  the  profit."  When 
Uncle  Sam  was  rich  enough  —  or  was  supposed  to  be  rich  enough 
—  to  provide  us  all  with  a  farm,  the  policy  of  giving  away  the 
public  domain  appeared  to  be  in  harmony  with  the  principle  of 
equality  of  opportunity.  But  when  the  supply  is  far  below  the 
demand,  those  who  receive  gifts  by  lot  or  similar  methods  are 
in  receipt  of  special  privileges.  What  once  seemed  fair  has,  in 
the  course  of  economic  evolution,  become  unfair  and  de- 
moralizing. 

Our  conclusion  may  be  formulated  in  the  following  general 
rule :  Only  those  lands  should  be  wholly  alienated  whose  use 
and  development  under  private  ownership  lead  neither  to  mo- 
nopoly nor  to  exhaustion  and  waste.  Or,  in  more  concrete 
terms  (remembering  that  the  maxim  applies  only  to  those  lands 
left  to  the  government,  and  to  the  majority  of  cases,  not  to  every 
specific  case),  the  rule  for  agricultural  lands  should  be  private 
ownership  and  management,  for  forest  lands  State  ownership 
and  management,  for  mining  and  grazing  lands  State  ownership 

1  Report  of  the  Secretary  of  the  Interior,  1905,  p.  331. 


PUBLIC   RECEIPTS  679 

and  private  management  under  a  lease  or  royalty  system,  by 
which  the  State  shall  secure  a  share  of  the  profits  and  retain  a 
large  amount  of  regulation  and  control.  In  disposing  of  its 
lands  the  government  should  endeavor  to  charge  value  received, 
as  gifts  of  valuable  land,  or  sales  at  inelastic  schedules  of  prices 
which  place  an  extreme  valuation  upon  some  tracts  and  an 
utterly  inadequate  valuation  upon  others,  lead  to  speculation 
and  monopoly,  having  most  of  the  demoralizing  features  of  a 
public  lottery  in  which  the  prizes  are  distributed  partly  by 
chance  and  partly  in  accordance  with  the  cunning,  chicanery, 
and  unscrupulousness  of  the  participators.  Under  existing  con- 
ditions the  poorer  classes  of  society  get  almost  none  of  the 
valuable  lands.  Charge  value  received,  and  the  people,  the 
masses,  get  their  share  in  the  revenues  flowing  to  the  public 
treasury,  in  reduced  taxes,  and  more  generous  expenditures 
for  educational,  protective,  and  developmental  purposes. 

Land  Nationalizav'on  and  Municipalization.  —  In  recent  years 
both  state  and  national  legislation  have  shown  a  decided  trend 
toward  the  adoption  of  methods  which  will  yield  both  greater 
revenue  and  greater  control  of  those  varied  forms  of  national 
wealth  which  we  collectively  designate  "  land."  The  object  of 
this  legislation  is  to  prevent  monopoly  and  give  to  society  a 
share  in  the  land  values  created  by  social  growth.  One  of  the 
most  ingenious  plans  for  securing  this  end  ever  proposed  is  the 
single-tax  scheme  defended  with  great  eloquence  and  earnestness 
by  the  late  Henry  George.  His  scheme,  usually  called  "  the 
single  tax,"  is  stated  thus  in  his  own  words,  printed  in  his  organ, 
The  Standarl: 

"  The  Standard  advocates  the  abolition  of  all  taxes  upon  industry  and  the 
products  of  industry,  and  the  taking,  by  taxation  upon  land  values,  irrespec- 
tive of  improvements,  of  the  annual  rental  value  of  all  those  various  forms  of 
natural  opportunities  embraced  under  the  general  term  '  land.' 

"We  hold  that  to  tax  labor  or  its  products  is  to  discourage  industry.  We 
hold  that  to  tax  land  values  to  their  full  amount  will  render  it  impossible 
for  any  man  to  exact  from  others  a  price  for  the  privilege  of  using  those 
bounties  of  nature  in  which  all  living  men  have  an  equal  right  of  use ;  that 
it  will  compel  every  individual  controlling  natural  opportunities  to  utilize 
them  by  employment  of  labor  or  abandon  them  to  others ;  that  it  will  thus 


08o  OUTLINES  OF  ECONOMICS 

provide  opportunities  of  work  for  all  men  and  secure  to  each  the  full  reward 
of  his  labor ;  and  that  as  a  result  involuntary  poverty  will  be  abolished,  and 
the  greed,  intemperance,  and  vice  that  spring  from  poverty  and  the  dread  of 
poverty  will  be  swept  away." 

Mr.  George's  proposition  rests  upon  an  extreme  application  of 
the  doctrines  of  individualism  and  natural  rights.  Man,  he 
holds,  has  an  inalienable  and  equal  right  to  live,  and  consequently 
an  inalienable  and  equal  right  to  those  natural  agents  which  we 
call  land,  and  without  which  human  life  cannot  exist.  This 
right  which  attaches  to  the  individual  cannot  be  abrogated  by 
law  or  custom,  nor  can  it  be  alienated  by  one  generation  or  set 
of  law  givers.  Moreover,  it  is  an  equal  right.  A,  B,  and  C 
each  have  a  right  to  the  soil,  but  A  has  no  right  to  better  soil 
than  B  or  C ;  in  consequence  of  which  that  part  of  land  values 
which  arises  from  the  differential  qualities  of  land  belongs  to 
society  as  a  whole,  and  not  to  particular  individuals.  But  the 
differential  value  of  land  expresses  itself  in  the  economic  rent 
which  it  yields,  and  consequently,  if  society  seizes  this  rent  by 
taxation,  it  will  satisfy  the  demands  of  the  doctrine  of  natural 
rights,  while  leaving  the  actual  management  and  exploitation 
of  land  in  the  hands  of  individual  occupiers,  thus  avoiding  the 
perils  of  direct  public  management. 

Man  also  has  an  unalienable  right,  Mr.  George  held,  to  the 
fruits  of  his  own  labor.  As  the  outcome  of  this  right,  Mr. 
George  concluded  that  ordinary  taxation  upon  property  other 
than  land,  upon  the  product  of  labor  as  distinguished  from  land, 
the  gift  of  God,  is  robbery.  In  his  view  it  is  as  immoral  to  levy 
an  ordinary  tax  as  it  is  criminal  to  fail  to  tax  that  surplus  which 
attaches  to  the  better  classes  of  lands,  and  which  we  call  economic 
rent. 

The  policy  embodied  in  Mr.  George's  scheme  differs  funda- 
mentally from  the  policy  which  we  have  seen  creeping  into  recent 
legislation.  The  latter  purposes  to  reserve  only  a  part  of  the 
value  given  to  some  forms  of  land  by  social  development.  Mr. 
George  proposes  to  confiscate  all  of  the  "  unearned  increment." 
Most  important  of  all,  the  former  proposition  applies  only  to  the 
future  unearned  increment,  and  purposes  only  to  take  a  part, 


PUBLIC   RECEIPTS  68 1 

and  that  only  after  fair  notice  is  given.  Mr.  George  proposes  to 
take  all  the  unearned  increment,  past  and  present,  and  that 
whether  the  present  owners  have  been  encouraged  to  believe  that 
they  might  be  permitted  to  appropriate  the  whole  unearned 
increment  or  not.  Herein  lies  the  essential  injustice  of  Mr. 
George's  scheme.  As  a  nation  we  have  induced  immigrants 
and  settlers  to  take  up  lands,  clear  them,  and  develop  them 
with  their  labor  and  toil,  with  the  promise  that  the  values  thus 
created  by  themselves  and  their  neighbors  should  belong  to 
them.  Their  risks  and  their  sacrifices  have  been  great.  The 
"  unearned  increment  "  is  not  always  unearned.  Even  if  we 
assume  that  the  State  made  a  mistake  in  pursuing  this  policy, 
the  results  of  the  mistake  must  be  cheerfully  borne  by  the  party 
at  fault,  the  State  itself.  This  of  course  does  not  mean  that  if 
the  private  ownership  of  land  is  socially  harmful,  it  must  never- 
theless be  perpetuated.  It  does  mean,  however,  that  if  the  state 
is  to  divest  private  owners,  it  must  in  equity  compensate  them. 

Mr.  George  not  only  proposes  to  confiscate  all  economic  rent 
without  compensation,  and  to  abolish  all  other  forms  of  taxa- 
tion, but  the  assertion  is  made  in  explanation  and  justification 
of  the  policy  that  it  will  abolish  poverty.  Such  a  policy  might, 
indeed,  prevent  landowners,  who  do  not  care  to  use  their  land, 
from  keeping  it  out  of  the  hands  of  those  who  would  use  it ;  but 
how  it  would  effect  all  the  other  predicted  blessings  is  difficult 
for  most  people  to  comprehend.  In  the  first  place,  it  is  difficult 
to  imagine  how  the  pure  economic  rent  of  agricultural  land  can 
be  separated  in  practice  from  the  annual  value  of  separable  im- 
provements on  the  land.  But  apart  from  this  difficulty,  the 
appropriation  of  economic  rent  by  the  public  without  compen- 
sation to  the  owners  will  probably  never  appeal  to  the  conscience 
of  the  American  public  as  a  just  thing  to  do.  No  abstract 
reasoning,  based  on  "  natural  rights,"  will  persuade  a  modern 
nation  to  so  radical  a  step.  This  honestly  and  earnestly  advo- 
cated policy  is  only  one  more  illustration  of  the  danger  of  basing 
social  reasoning  on  any  theory  of  "  natural  rights." 

In  cities  it  is  easier  to  separate  the  pure  economic  rent  from 
the  earnings  of  improvements,  such  as  buildings.     Moreover,  it 


682  OUTLINES  OF  ECONOMICS 

is  in  cities  that  the  principal  evils  attendant  on  private  land- 
holding  are  discoverable.  Therefore  the  objections  to  land 
nationalization  do  not  in  the  same  degree  apply  to  land  munici- 
palization. Many  who  will  reject  the  one  will  favor  the  other. 
Even  here,  however,  it  is  well  to  proceed  very  cautiously.  Con- 
fiscation, at  any  rate,  should  not  be  tolerated.  If  great  and 
expensive  changes  along  this  line  should  approve  themselves  to 
the  people,  the  burden  of  the  changes  should  be  widely  diffused 
throughout  the  community  by  means  of  inheritance  and  other 
taxes.1 

Public  Industries.  —  In  the  beginning,  let  us  briefly  pass  in 
review  the  principal  classes  of  industrial  enterprise  in  which  the 
modern  State  engages  for  the  satisfaction  of  other  than  State 
wants ;  because,  obviously,  we  are  not  concerned  with  enter- 
prises like  the  government  printing  office,  the  government  navy 
yards,  and  in  general,  those  incidental  industries  whose  products 
the  government  consumes  but  does  not  regularly  sell. 

i.  First,  we  find  states  like  Switzerland  monopolizing  the 
manufacture  of  alcohol  and  certain  alcoholic  beverages,  Japan 
monopolizing  the  opium  traffic  in  Formosa,  or  commonwealths 
like  South  Carolina  engaging  at  one  time  in  the  retail  distribu- 
tion of  intoxicating  beverages.  The  purpose  of  the  State  in 
engaging  in  such  industries  is  primarily  sumptuary ;  it  is  desired 
to  regulate  the  traffic  almost  to  the  point  of  suppression,  per- 
haps. Ordinarily  a  good  revenue  would  be  secured,  but  revenue 
is  a  very  secondary  consideration.  Prices  will  be  placed  above 
the  level  of  highest  net  profit,  and  not  improbably  the  ideal  of 
regulating  consumption  will  be  so  vigorously  pursued  that  profits 
will  disappear  altogether. 

2.  Secondly,  we  have  the  group  of  so-called  "  fiscal  monopo- 
lies." France,  for  instance,  monopolizes  the  manufacture  of 
matches,  cigarettes,  and  tobacco  in  general ;  Japan  has  recently 
gone  farther  than  any  other  country  in  the  creation  of  fiscal 
monopolies ;  while  Prussia,  Austria,  Italy,  Spain,  and  other 
European  countries  maintain  public  lotteries  —  as  did  many  of 
the  American   colonies  during   the   eighteenth  century.     The 

1  See  pp.  425  and  706  for  further  discussion  of  the  single  tax. 


PUBLIC   RECEIPTS  683 

primary  object  of  the  State  in  undertaking  these  enterprises  is 
public  revenue,  gain  ;  and  naturally  a  monopoly  price  is  charged, 
the  price  which  will  yield  the  greatest  net  revenue. 

3.  Next,  we  have  a  group  of  enterprises  consisting  principally 
of  the  so-called  "  natural  monopolies,"  which  the  State  under- 
takes not  for  suppression,  not  for  profit,  but  primarily  for  regu- 
lation —  to  regulate  the  quality  of  the  product,  as  in  the  case 
of  water ;  to  maintain  effectively  what  have  been  called  "  equi- 
table conditions  for  the  prosecution  of  private  business,"  as  in 
the  case  of  railways;  to  prevent  monopolistic  extortion  and 
corporate  abuse,  as  in  the  case  of  lighting  companies,  the  post 
office,  the  telegraph,  and  the  telephone ;  or  to  prevent  crime  and 
preserve  intact  the  foundations  of  commercial  prosperity,  as  in 
the  monopoly  of  coinage.  The  charges  here  are  ordinarily  ad- 
justed to  either  the  "  revenue  "  or  the  "  cost  "  principle,  that 
is  to  say,  the  State  will  either  aim  to  make  a  fair  business  profit 
such  as  is  secured  in  competitive  private  enterprises,  or  it  will 
endeavor  approximately  to  meet  expenses  by  adjusting  its 
charges  to  the  cost  of  production.  England,  France,  and  Ger- 
many, in  ordinary  years,  obtain  handsome  revenues  from  their 
respective  postal  departments,  but  in  the  United  States  the 
accounts  of  the  Post  Office  Department  usually  show  an  annual 
deficit,  and  taking  the  world  over,  the  cost  principle  in  this 
group  of  industries  is  probably  more  common  than  the  revenue 
principle,  and  deficits  more  common  than  net  profits.  In  the 
United  States  the  post  office  has  always  been  regarded  as  a 
developmental  agency  rather  than  a  business  enterprise,  and 
might  more  logically,  perhaps,  be  included  in  the  next  category. 

4.  Finally,  we  have  a  large  and  heterogeneous  group  of  in- 
dustries which  are  maintained  principally  for  service,  for  their 
educational  and  developmental  influence,  not  primarily  for  regu- 
lation, and  not  at  all  for  profit,  but  "  for  the  public  good."  We 
include  here  not  only  schools  and  educational  institutions  of  all 
kinds,  but  roads  and  canals ;  the  savings  banks  and  public  pawn 
shops  maintained  in  several  countries  of  continental  Europe ; 
workingmen's  insurance  as  developed  by  Germany,  Austria, 
and  several  of  the  Australian  commonwealths ;  and  model  manu- 


684  OUTLINES  OF   ECONOMICS  v 

facturing  establishments  such  as  France  maintains  for  the  pro- 
duction of  tapestries  and  fine  porcelains.  In  this  group  charges 
will  sink  to  a  minimum,  and  in  some  lines  of  enterprise,  such  as 
education,  practically  disappear.  Revenue  here  is  not  only  a 
minor,  but  is  almost  a  negligible,  consideration. 

A  brief  consideration  of  the  incomplete  list  of  State  industries 
given  above  brings  out  several  important  truths.  In  the  first 
place,  it  is  evident  that  only  a  few  of  these  industries,  the  fiscal 
monopolies,  have  been  taken  over  by  the  State  for  the  purpose 
of  revenue,  and  fiscal  monopolies  are  decreasing  rather  than 
increasing  in  relative  importance.  In  the  second  place,  it  is 
equally  as  clear  that,  on  the  whole,  public  industries  are  sources 
of  expense  and  not  of  profit.  When  Professor  Bastable,  for  ex- 
ample, tells  us  that  in  England,  in  the  fiscal  year  1 893-1 894, 
only  6  per  cent  of  the  national  revenue  came  from  public  indus- 
tries and  other  non-tax  sources,  that  in  the  local  revenues  of 
England  and  Wales  (1891-1892)  taxation  stood  to  other  sources 
of  revenue  in  the  ratio  of  five  to  one,  that  in  Prussia  about  20 
per  cent  of  the  national  revenue  comes  from  the  domain  and  in- 
dustrial enterprises,  and  in  India  something  less  than  50  per 
cent  from  "  quasi-private  sources  of  revenue,"  he  is  careful  to 
warn  us  that  the  statistics  take  no  cognizance  of  interest  pay- 
ments chargeable  to  the  several  industries,  or  of  depreciation, 
or  of  related  industries  in  which  deficits  and  not  profits  were 
secured.  When  estimating  the  importance  of  State  railway 
earnings  in  the  revenue  account,  no  cognizance  is  ordinarily 
taken  of  the  canal  deficit.  In  the  third  place,  we  perceive  from 
the  nature  of  the  industries  that  they  cannot  wisely  be  operated 
for  profit  in  many  cases.  Education,  for  instance,  has  been 
taken  over  by  the  State  for  the  very  purpose  of  charging  less 
than  the  cost  of  the  service.  The  unquestionable  tendency  is  for 
the  prices  of  goods  and  services  supplied  by  a  democratic  State 
to  sink  below  the  cost  of  production,  and  this,  in  itself,  is  neither 
good  nor  bad,  fortunate  nor  unfortunate.  The  public  financier, 
in  adjusting  the  charges,  must  not  look  to  profit.  His  only  aim 
is  the  salus  populi,  and  this  policy  requires  here  a  prohibitive 
price,  there  a  cost  price,  and  again  free  service.     Finally,  it 


PUBLIC   RECEIPTS  685 

appears,  the  problem  of  public  charges  can  be  settled  only  with 
reference  to  a  particular  time,  place,  and  industry.  England 
finds  it  expedient  to  raise  a  handsome  revenue  from  her  post 
office,  while  in  most  years  the  United  States  manages  her  post 
office  at  a  loss.  Waterworks  are  successfully  conducted  by  most 
of  the  large  American  municipalities,  but  public  lighting  experi- 
ments in  this  country  have  not  been  equally  successful.  India 
raises  half  of  her  revenues  from  non-tax  sources  largely  because 
heavy  taxation  of  the  ordinary  kind  would  be  impossible.  The 
French  tobacco  monopoly  succeeds  because  the  French  govern- 
ment can  supervise  and  trace  almost  every  pound  of  tobacco 
grown  in  France.  In  the  United  States  this  would  be  impossible. 
Although  we  cannot  decide  in  a  general  way  what  theory  of 
charges  should  be  followed  in  particular  public  industries,  it  is 
possible  to  lay  down  general  rules  which  will  assist  us  in  reach- 
ing a  correct  conclusion  in  specific  cases.  Assuming  that  the 
industry  in  question  supplies  a  service  rather  than  a  commodity, 
merely  to  save  words  in  the  discussion,  we  must  first  of  all  in- 
quire :  (1)  Is  the  service  helpful  or  harmful  in  its  net  social 
effect?  According  as  it  is  one  or  the  other,  we  will  incline  in 
our  charges  toward  the  gratuity  principle  or  the  prohibitive 
principle.  If  harmful,  however,  it  is  plain  that  we  must  not 
make  the  charges  high  enough  to  encourage  smuggling  or  illicit 
manufacture.  If  helpful,  on  the  other  hand,  we  cannot  at  once 
decide  upon  the  gratuity  principle,  but  must  inquire  further : 
(2)  How  generally  is  the  service  enjoyed  ?  If  only  a  small  portion 
of  the  community  enjoys  the  service,  it  would  usually  be  unjust 
to  charge  less  than  cost,  because  the  deficit  would  be  borne  by 
general  taxation  falling  upon  the  entire  community ;  unless,  in- 
deed, the  benefit  to  one  restricted  class  is  seen  to  be  of  advantage 
to  the  whole  community  in  such  a  degree  that  the  rest  of  the 
community  is  willing  to  bear  the  deficit,  as  in  the  case  of  public 
charity. 

(3)  Assuming  that  the  service  benefits  the  whole  community, 
this  is  still  not  sufficient  to  justify  a  charge  less  than  the  cost  of 
production.  The  problem  is  one  of  comparative  costs.  We 
must  inquire  whether  greater  benefit  would  not  be  secured  by 


686  OUTLINES  OF   ECONOMICS 

charging  enough  to  raise  a  profit  and  then  distributing  that  profit 
through  the  maintenance  of  some  other  gratuitous  enterprise, 
or,  if  the  tax  system  weighs  heavily  on  the  poor,  by  remitting 
taxation  to  the  extent  of  the  profit  (4)  If  all  these  questions  are 
answered  in  favor  of  the  gratuity  principle,  we  still  must  con- 
sider what  effect  gratuitous  service  will  have  upon  the  cost 
of  the  service.  Will  it  encourage  wastefulness?  Free  city 
water,  for  example,  would  probably  prove  impracticable  because 
of  waste,  but  free  parks  or  free  education  do  not  lead  to  inordi- 
nate or  unnecessary  consumption.  The  question  is  a  vital  one, 
but  it  is  not  always  to  be  answered  one  way,  as  some  critics  of 
government  ownership  seem  to  believe.  (5)  Closely  related  to 
the  above  is  the  question  of  pauperization.  Some  things  the 
State  may  safely  give  away,  and  some  not.  The  modern  city, 
for  example,  may  give  free  band  concerts,  in  our  view,  to  the 
undoubted  edification  of  the  community;  but  in  Rome  the 
public  games  demoralized  the  populace.  (6)  Finally,  we  have 
to  ask  what  effect  gratuitous  service  will  have  on  incomes. 
Henry  George  proposed  that  our  cities  should  operate  the  street 
car  lines  gratuitously,  and  the  argument  in  its  favor  is  far 
stronger  than  might  be  expected  on  first  thought.  But  what 
effect  would  this  gratuitous  service  have  upon  the  incomes  of 
the  laboring  classes  ?  Take  the  case  of  the  worker  in  New  York 
City  earning  $3.00  a  day.  Will  his  wages  remain  at  $3.00,  if 
street  car  service  is  offered  free  of  charge  ?  Will  not  the  migra- 
tion to  New  York  be  increased,  so  that  wages  will  fall?  And 
may  not  the  gain  ultimately  fall  to  owners  of  house  property  in 
the  form  of  enhanced  rents? 

All  these  questions  must  be  answered  before  the  tariff  of 
charges  can  be  adopted,  and  it  is  plain  that  the  answers  will  be 
determined  by  the  particular  conditions  of  time,  industry,  and 
place,  particularly  by  the  character  of  the  industry.  The  nearest 
approach  to  a  general  rule  which  can  be  formulated,  may  be 
stated  as  follows :  In  proportion  as  a  service  or  commodity  tends 
to  the  upbuilding  of  character  and  personality,  we  should,  so  far 
as  fiscal  conditions  permit,  gradually  move  in  the  direction  of 
the  principle  of  gratuitous  service.     If  the  service  or  commodity 


PUBLIC   RECEIPTS  687 

itself  is  widely  consumed  and  is  as  desirable  as  any  vendible 
commodities  which  would  probably  be  purchased  from  possible 
revenues  yielded  by  charges  for  the  service,  particularly  if  large 
consumption  is  desirable  and  waste  in  consumption  does  not 
become  excessive,  the  principle  of  gratuitous  service  may  be 
recommended. 

Limitations  of  space  prevent  further  treatment  of  the  subject 
of  public  industries.  The  important  thing  to  understand  is  that 
the  moment  an  industry  is  taken  over  by  the  government,  that 
moment  the  question  of  profit  —  which  is  the  vital  considera- 
tion under  private  management  —  becomes  of  secondary  im- 
portance, subordinate  to  questions  of  public  policy ;  and  the 
interjection  of  public  policy  into  the  determination  of  prices  or 
charges,  creates  a  problem  whose  complexity  and  difficulty  can 
scarcely  be  exaggerated.  At  the  present  time,  for  instance,  we 
do  not  even  know  whether  our  postal  rates  on  second  class  mail 
matter  pay  for  the  cost  of  carriage  and  delivery,  to  say  nothing 
of  the  question  whether  such  matter  ought  to  be  carried  at  less 
than  cost.  Just  now  the  indications  are  that  the  State  will 
take  over  an  increasing  number  of  industries,  or  at  least  exert  a 
constantly  increasing  influence  upon  the  rates  and  charges  of 
quasi-public  industries.  Under  these  circumstances  our  present 
duty  is  to  institute,  both  in  public  and  quasi-public  industries, 
a  thoroughgoing  system  of  cost  accounting,  so  that  we  shall 
understand  upon  what  footing  each  branch  of  the  industry  rests. 
Our  second  duty,  which  falls  primarily  upon  economists  and 
statesmen,  is  to  develop  a  far  more  satisfactory  theory  of  public 
charges,  for  at  the  present  time  we  hardly  understand  the  many 
factors  that  must  be  considered  in  this  problem,  much  less  the 
net  meaning  or  resultant  of  these  factors. 

QUESTIONS 

1.  Are  public  debts  a  burden  when  represented  by  paying  investments? 
by  non-revenue-bearing  investments? 

2.  Do  State  debts  indicate  impoverishment  of  the  people?    Why? 

3.  What  defects  are  found  in  the  sinking-fund  method  of  retiring  public 
debts?    Enumerate  the  advantages  of  the  serial  bond. 


6S8  OUTLINES  OF  ECONOMICS 

4.  How  was  the  State  supported  in  primitive  times?  What  connection 
:s  there  between  taxation  and  representative  government? 

5.  What  has  been  the  principal  aim  of  the  United  States  in  the  manage- 
ment of  public  lands?     How  has  this  aim  changed? 

6.  Why  do  the  poorer  classes  benefit  least  by  the  homestead  acts  and  by 
the  sale  of  the  public  lands  at  prices  below  their  real  value  ? 

7.  What  kinds  of  land  should  be  both  owned  and  managed  by  govern- 
ment?    Why? 

8.  What  are  the  advantages  and  disadvantages  of  the  royalty  or  lease 
system?     To  what  kinds  of  land  should  it  be  applied? 

9.  What  conflict  is  there  between  modern  industrial  methods  and  the 
project  of  giving  land  to  the  landless? 

10.  What  connection  is  there  between  "natural  right"  and  the  single-tax 
scheme  ? 

n.  Is  there  any  absolute,  inalienable  right  to  life?  to  anything?  Ex- 
plain. 

12.  Should  State  industries  be  managed  so  as  to  yield  a  profit?  Is  a 
profit  inconsistent  with  good  State  management?  Is  any  general  tendency, 
with  respect  to  profits,  discernible  in  the  management  of  particular  public 
industries? 

REFERENCES 

Adams,  H.  C.     Public  Debts ;  The  Science  of  Finance,  pp.  237-260,  261-282. 

Bastable,  C.  F.     Public  Finance,  3d  ed.,  pp.  157-178,  179-218,  219-232. 

Bullock,  C.  J.  Selected  Readings  in  Public  Finance,  Chap,  iv,  "The  Views 
of  Bodin  and  Smith,"  pp.  50-60;  Chap,  v,  "Revenues  from  Domains."' 
pp.  61-72;   Chap,  vi,  "Revenues  from  Public  Industries,"  pp.  80-116. 

Bureau  of  the  Census.  Reports  on  Wealth,  Debt,  and  Taxation,  and  Statistics 
of  Cities. 

Cohn,  Gustav.  The  Science  of  Finance  (translated  by  Thorstein  Veblen), 
pp.  82-103. 

Daniels,  W.  M.     The  Elements  of  Public  Finance,  pp.  207-223,  285-314. 

Gricf.,  J.  W.     National  and  Local  Finance. 

Hewes,  L.  I.,  and  Glover,  J.  W.  Highway  Bonds.  (Bulletin  of  the  U.S. 
Department  of  Agriculture,  Xo.  136.) 

Plehn,  C.  C.     Introduction  to  Public  Finance,  3d  ed.,  Part  iii. 

Raymond,  W.  L.     American  and  Foreign  Investment  Bonds,  Chaps,  ii-v. 

Report  of  the  Public  Lands  Commission,  Senate  Document  No.  189,  58th  Con- 
gress, 3d  Session,  pp.  iii-xxiv. 

Scott,  W.  A.     The  Repudiation  of  Stale  Debts. 

Seligman,  E.  R.  A.  "Classification  of  Public  Revenues,"  in  his  Essays  in 
Taxation,  rev.  ed.,  Chap.  xiv. 

U.S.  Department  of  Agriculture,  Forest  Service.     The  Use  Book. 

Van  Hise,  C.  R.     The  Conservation  of  National  Resources  in  the  United  States. 


CHAPTER  XXXIII 

PUBLIC     RECEIPTS     FROM     FEES,     SPECIAL    ASSESS 
MENTS,   AND    TAXES 

Definitions.  —  If  the  reader  will  run  over  the  classification  of 
public  industries  given  in  the  preceding  chapter,  he  will  notice 
that  the  corresponding  payments  —  which  descend,  it  will  be 
remembered,  from  prohibitive  to  gratuity  charges  —  fall  into 
two  main  classes:  those  imposed  upon  the  consumer  or  pur- 
chaser who  specially  benefits  by  the  service,  and  those  —  like 
the  revenues  devoted  to  the  maintenance  of  education  and  pub- 
lic parks  —  imposed  upon  the  tax-paying  public  generally,  irre- 
spective of  the  benefits  conferred  by  the  service.  Moreover, 
as  we  move  from  the  prohibitive  to  the  gratuity  group,  there  is 
a  general  though  not  regular  change  in  the  degree  and  kind  of 
compulsion  exercised  by  the  State  in  collecting  the  contribution. 
The  State  does  not  encourage  the  purchase  of  intoxicating  liquors 
under  the  Gothenburg  system  in  order  that  the  revenue  may  be 
as  large  as  possible,  —  it  actually  discourages  their  sale ;  the  use 
of  the  postal  money  order  is  mildly  encouraged,  but  you  may 
send  your  money  by  express  if  you  desire ;  one  is  not  forced  to 
marry,  but  if  one  marries  one  is  compelled  to  take  out  a  mar- 
riage license ;  and  whether  onp  uses  the  public  schools  or  not, 
one  must  help  pay  for  their  maintenance.  Finally,  it  will  be 
noticed  that  as  the  element  of  compulsion  increases,  the  public 
interest  in  the  service  changes,  and  generally  though  not  always 
increases.  The  wood  sold  from  the  government  forests  is 
merely  a  commercial  by-product  of  an  enterprise  maintained 
by  the  government  for  other  purposes ;  the  marriage-license 
fee  benefits  the  individual,  but  is  imposed  primarily  to  protect 
the  morals  of  the  community;  while  the  tax  to  maintain  the 
public  schools  is  paid  solely  for  the  purpose  of  benefiting  the 
general  public. 

2  y  680 


690  OUTLINES  OF   ECONOMICS 

There  are,   then,   three  general  principles  of  classification: 

(1)  the  assignability  of  the  benefit  of  the  service  to  an  individual ; 

(2)  the  degree  of  compulsion  exercised  by  the  State ;  (3)  the 
degree  and  kind  of  public  interest  involved  in  the  service.  The 
more  voluntary  payments  for  the  more  commercial  services  made 
by  persons  who  receive  a  special  benefit  from  these  services  are 
called  public  prices;  the  less  voluntary  payments  for  services  in 
which  the  public  interest  is  less  commercial  in  character,  made 
by  persons  who  receive  a  special  benefit  from  the  services,  are 
called  fees.  Compulsory  contributions,  "  levied  in  proportion 
to  the  special  benefits  derived,  to  defray  the  cost  of  a  specific 
improvement  to  property,  undertaken  in  the  public  interest," 
are,  in  the  United  States,  called  special  assessments ;  and  com- 
pulsory contributions,  exacted  by  public  authority  according 
to  some  general  rule,  without  reference  to  the  special  benefit 
conferred  by  the  services  to  whose  maintenance  the  contribu- 
tions are  devoted,  are  called  taxes. 

The  student  is  warned  that  little  regard  is  paid  to  these  dis- 
tinctions in  everyday  usage.  The  words  "fees,"  "taxes," 
"  licenses,"  "  tariffs,"  "  rates,"  "  charges,"  and  the  like  are 
hopelessly  confused ;  and  even  census  statisticians  find  it  im- 
possible to  distinguish,  in  public  accounts  as  they  are  now  kept, 
between  prices,  fees,  rentals,  licenses,  and  some  kinds  of  taxes. 
The  utility  of  the  terms  is  in  emphasizing  the  important  truth 
that  these  great  categories  of  public  contributions  must  be  dis- 
tinguished and  differently  treated  by  the  legislator  and  student, 
by  whatever  terms  the  different  categories  are  designated. 

Fees.1  —  In  the  exercise  of  its  most  fundamental  and  general 
functions,  the  government  frequently  confers,  in  an  incidental 
way,  special  benefits  upon  particular  individuals.  Thus  the 
courts,  whose  function  it  is  to  administer  justice  in  general,  find 
that  this  function  must  be  performed  by  deciding  disputes  be- 
tween particular  litigants,  one  of  whom  usually  benefits  by  the 

1  Public  prices  have  been  discussed  in  the  preceding  chapter.  The  small  tuition 
charges  paid  by  students  in  state  universities  offer  a  good  illustration  of  fees ;  they 
are  non-commercial  in  character,  semi-voluntary,  and  in  amount  fall  considerably 
short  of  the  cost  of  the  service. 


PUBLIC  RECEIPTS  69 1 

decision.  Now  if  the  government  is  disposed  to  take  advantage 
of  the  opportunity,  it  is  evident  that  much  revenue  may  be 
raised  from  the  individuals  who,  in  a  more  or  less  adventitious 
way,  benefit  from  the  government  activities ;  and  where  the 
nation  is  poor  or  the  people  averse  to  taxation,  much  dependence 
will  be  placed  upon  fees.  As  wealth  increases,  however,  and 
the  government  becomes  more  democratic,  there  is  a  growing 
disposition  to  support  general  functions  by  general  contributions 
—  taxes  —  and  the  relative  importance  of  fees  is  likely  to  de- 
cline. On  the  other  hand,  there  is  no  likelihood  that  fees  will 
wholly  disappear,  as  they  exercise  a  wholesome  influence  in  pre- 
venting waste.  Court  fees,  for  instance,  would  probably  have 
been  abolished  before  this,  if  they  did  not  serve  to  prevent 
litigious  persons  from  carrying  their  quarrels  to  the  courts  for 
settlements.  Because  of  this  restrictive  and  economical  in- 
fluence exercised  by  fees,  they  will  undoubtedly  retain  a  per- 
manent place  in  the  public  revenr3s  of  even  the  more  advanced 
and  democratic  states ;  but  their  fiscal  importance  will  very 
likely  decline. 

During  the  colonial  epoch  the  fee  system  was  much  abused  in 
America,  many  offices  being  wholly  maintained  by  fees  which 
should  have  been  abolished  or  supported  by  taxation.  At  the 
present  time,  however,  the  evils  of  the  system  arise  not  from 
the  number  or  amount  of  fees,  but  from  their  connection  with 
the  salaries  of  certain  public  officials.  Many  officials  are  allowed 
to  keep  the  fees  which  they  collect  in  lieu  of  fixed  salaries,  and 
this  practice  results  in  very  serious  evils.  In  the  first  place, 
some  fee-paid  offices,  particularly  those  of  sheriff  and  register 
of  deeds  in  populous  districts,  have  come  to  yield  princely  in- 
comes, and  the  scramble  for  these  rich  offices  constitutes  a  pro- 
lific source  of  political  corruption.  In  the  second  place,  fee  pay- 
ment cf  public  officials  often  impels  them  to  an  excessive  and 
pernicious  activity,  in  which  their  own  interests  and  those  of  the 
commonwealth  are  placed  in  direct  conflict.  In  a  few  states, 
for  instance,  prosecuting  attorneys  are  paid  so  much  per  con- 
viction, the  fee  increasing  with  the  heinousness  of  the  offense, 
while  in  many  cities  and  villages  the  police  force  and  citv  courts 


692  OUTLINES   OF  ECONOMICS 

are  supported  partially  by  fees  and  fines.  Under  these  circum- 
stances, officials  bend  their  activity  to  the  conviction  of  offenders, 
not  to  the  prevention  of  crime  and  the  reform  of  the  criminal ; 
they  frequently  set  traps  for  persons  who  are  likely  to  break  the 
law,  creating  the  temptation  and  the  opportunity  in  order  that 
they  may  increase  their  emoluments.  In  Wisconsin,  sheriffs 
were  for  many  years  paid  so  much  per  head  for  the  tramps  whom 
they  fed  and  lodged.  The  system,  as  has  been  said,  placed  a 
"  direct  premium  upon  vagrancy."  1  During  the  existence  of 
this  system  in  Wisconsin,  tramps  were  "  often  furnished  with 
liquor,  tobacco,  and  newspapers,  to  induce  them  to  return." 
Finally,  the  fee  system  has  been  a  constant  and  shameful  cor- 
rupter of  justice  as  dispensed  by  justices  of  the  peace  in  "  the 
people's  courts."  In  most  states  there  are  several  justice's 
courts  open  to  the  plaintiff  who  desires  to  bring  suit.  In  con- 
sequence, a  disgraceful  competition  springs  up,  each  justice  en- 
deavoring to  swell  his  business  and  multiply  his  fees  by  con- 
stantly finding  for  the  plaintiff,  with  the  result  that  our  judicial 
system  is  thoroughly  vicious  at  the  point  where  perhaps  it  comes 
in  closest  contact  with  the  masses  of  the  people. 

The  remedy  is  in  the  substitution,  wherever  possible,  of  regu- 
lar salaries  for  fee  stipends,  and  in  the  institution  of  methods  of 
accounting  which  will  hold  public  officials  to  strict  accountability 
for  every  fee  collected.  Fortunately,  the  movement  of  legisla- 
tion, while  slow  and  obstinately  fought  by  some  politicians,  is  in 
the  right  direction ;  and  in  almost  every  state  public  officials 
are  being  required  to  turn  their  fees  into  the  general  treasury 
and  accept  instead  a  fixed  compensation. 

Special  Assessments.  —  Where  the  operations  of  the  govern- 
ment confer  a  special  benefit  upon  some  restricted  group  of  in- 
dividuals, those  individuals  are  often  led  to  exercise  undue  in- 
fluence upon  the  government  to  secure  that  service,  if  the  latter 
is  supported  by  appropriations  from  the  general  funds.  Jobbery 
and  graft  are  encouraged.  On  the  other  hand,  if  the  only  way 
the  group  of  individuals  can  secure  the  service  is  by  expenditure 

1  T.  K.  Urdahl,  The  Fee  System  in  the  United  States,  p.  211.  The  other  quotations 
ated  in  this  section  are  taken  from  this  work. 


PUBLIC   RECEIPTS  693 

of  the  common  funds,  the  government  or  legislature  often  delays 
the  expenditure  unduly  for  fear  of  criticism  or  because  of  unwise 
parsimony.  Thus  in  cities  where  the  method  of  special  assess- 
ment is  not  used,  it  often  happens  that  the  opening  of  a  street 
is  delayed  long  after  the  time  when  it  would  be  desirable  for 
the  citizens  most  interested,  although  perhaps  the  latter  would 
be  willing  to  defray  the  cost  from  their  own  pockets,  were  this 
permitted. 

A  recognition  of  these  facts  has  led  in  recent  years  to  a  strik- 
ing development,  in  the  United  States,  of  the  benefit  principle 
as  exemplified  in  the  method  of  special  assessments.  The  special 
assessment  has  been  used  sporadically  in  many  countries  for 
several  centuries,  but  it  was  first  regularly  used  on  a  wide  scale 
in  the  United  States,  in  the  latter  half  of  the  nineteenth  century. 
Its  place  and  importance  among  the  revenues  is  shown  in  the 
table  on  page  695,  from  which  it  appears  that  special  assess- 
ments aggregating  over  $113,000,000  were  collected  in  1902. 
This  amount  constituted  a  little  more  than  4  per  cent  of  the 
revenue  receipts;  but  as  the  national  and  state  governments 
(except  Massachusetts)  make  practically  no  use  of  the  special 
assessment,  its  real  importance  appears  more  clearly  from  an 
examination  of  its  place  among  municipal  revenues.  In  the 
incorporated  places  having  2500  inhabitants  or  over  in  1913, 
special  assessments  yielded  nearly  9  per  cent  of  the  revenues 
and  more  than  one  eighth  as  much  revenue  as  all  kinds  of  taxes. 

The  special  assessment  has  been  approved  by  the  American 
courts  because  it  places  at  least  a  part  of  the  cost  of  the  service 
upon  the  beneficiaries  of  the  service,  a  rule  which  can  sometimes, 
but  not  often,  be  violated  without  subjecting  the  government  to 
excessive  and  corrupting  private  influence.  The  special  assess- 
ment has  appealed  to  the  people,  however,  because  it  permits 
public  improvements  to  go  ahead  at  a  pace  which  would  be  im- 
possible if  taxation  were  the  only  fund  for  defraying  the  cost  of 
the  improvements.  Needless  to  say,  the  special  assessment  has 
occasionally  stimulated  extravagance  and  premature  develop- 
ment. Thus,  in  New  Jersey,  in  the  last  quarter  of  the  nineteenth 
century,  several  large  cities  were  practically  thrown  into  bank- 


094  OUTLINES  OF   ECONOMICS 

ruptcy  by  undertaking  ambitious  public  works,  in  which  the 
special  assessment  played  an  important  part.  And  in  New  York, 
under  the  Tweed  regime,  the  system  of  special  assessments  fur- 
nished an  excuse  for  undertaking  public  works  in  which  corrup- 
tion flourished,  and  which  probably  would  never  have  been  under- 
taken, had  it  been  known  in  the  beginning  that  their  cost  would 
have  to  be  partially  defrayed  by  taxation.  "  The  works  had 
been  carried  on  upon  a  scale  of  audacious  extravagance,  and  in 
portions  of  the  city  where  they  were  not  at  the  time  justified. 
Great  avenues  were  laid  out  and  improved  largely  for  the  pur- 
pose of  giving  fat  jobs  to  favorite  contractors,  and  to  provide 
fine  drives  for  the  pleasure  and  convenience  of  others  than  the 
abutting  property  owners."  1 

On  the  whole,  however,  the  special  assessment  has  been  an 
unusual  success  as  a  fiscal  expedient,  and  has  proved  an  im- 
portant, if  not  an  indispensable,  factor  in  the  development  of 
American  cities.  Where  its  use  has  been  followed  by  extrava- 
gance, speculation,  or  jobbery,  these  evils  are  to  be  attributed 
almost  wholly  to  political  corruption  of  the  government,  and 
only  in  a  very  small  measure  to  the  special  assessment  itself. 
Most  of  the  evils,  moreover,  have  arisen  where  the  city  govern- 
ment, or  some  department  of  the  city  government  like  that  of 
public  works,  has  been  given  the  power  to  order  the  improve- 
ments against  the  will  of  the  property  owners  involved  or  where, 
as  was  the  case  in  the  example  cited  above,  assessments  upon 
particular  lots  were  permitted  to  exceed  the  value  of  the  prop- 
erty. Special  assessments  should  not  be  levied  against  the  will  of 
a  majority  of  the  property  holders  subject  to  assessment,  except 
by  a  two  thirds  or  three  fourths  vote  of  the  city  council,  and  in 
no  case  should  the  assessment  exceed  a  small  fraction  of  the 
value  of  the  property  against  which  the  assessment  is  laid. 
Where  these  rules  are  observed,  the  special  assessment  is  un- 
likely to  lead  either  to  premature  development  or  hardship 
upon  the  property  holder. 

Taxes.  —  In  this  country  more  than  70  per  cent  of  all  the 
public  revenues  are  obtained  from  taxes,  so  the  problems  of 

'Victor  Rosewater,  Special  Assessments. 


PUBLIC   RECEIPTS 


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696  OUTLINES  OF   ECONOMICS 

taxation  are  the  most  important  with  which  the  public  financier 
has  to  deal.  These  problems  are  of  two  varieties ;  those  deal- 
ing with  the  nature  of  taxation  in  general,  and  those  dealing 
with  specific  taxes.  The  remainder  of  this  chapter  will  be  de- 
voted to  the  general  questions.  The  following  chapter  will  be 
given  over  to  the  more  specific  problems  of  American  taxation. 
Justice  in  Taxation.  —  By  far  the  most  important  lesson  which 
the  student  of  fiscal  questions  has  to  learn  is  the  supreme  neces- 
sity for  tolerance  and  breadth  of  view.  The  factors  which  con- 
dition justice  or  make  for  equity  in  taxation  are  exceedingly 
numerous ;  and  the  mistake  most  commonly  made  by  superficial 
thinkers  is  to  seize  upon  some  one  element  of  justice,  build  a 
philosophy  upon  that  alone,  and  vigorously  condemn  every- 
thing that  does  not  harmonize  with  their  petty  and  bigoted  little 
system.  No  rule  less  sweeping  than  that  of  the  general  wel- 
fare can  serve  as  a  safe  guide  in  public  finance. 

1.  Some  writers  go  so  far  as  wholly  to  deny  the  right  of  the 
State  to  take  private  property  by  taxation.  These  writers  for- 
get that  there  is  no  such  thing  as  absolutely  private  property. 
As  the  State  determines  what  shall  be  private  property,  so  also 
it  determines  the  conditions  of  its  existence,  and  the  most  funda- 
mental condition  of  private  property  is  the  obligation  to  con- 
tribute to  the  support  of  the  State.  The  rights  of  private  in- 
dividuals have  always  been  of  a  more  or  less  limited  nature,  and 
among  the  rights  reserved  by  the  people  in  their  organic  capacity 
will  be  found,  in  every  civilized  state,  the  right  to  take  a  portion 
of  the  wealth  produced  for  such  purposes  as  the  lawmaking 
power  may  deem  fit. 

2.  However,  the  State  must  exercise  this  power  over  private 
property  in  an  equitable  manner,  or  as  this  maxim  is  ordinarily 
expressed  in  the  terminology  of  constitutional  law,  taxation 
must  be  equal  and  uniform.  Thus,  for  example,  the  constitu- 
tion of  West  Virginia  provides  that :  "  Taxation  shall  be  equal 
and  uniform  throughout  this  state,  and  all  property,  real  and 
personal,  shall  be  taxed  in  proportion  to  its  value,  to  be  ascer- 
tained as  directed  by  law."  Now,  if  we  examine  the  way  in 
which  these  requirements  of  equality  and  uniformity  have  been 


PUBLIC   RECEIPTS  697 

interpreted  in  the  administration  of  practical  justice,  we  find 
that  equality  and  uniformity  have  come  to  mean  little  more 
than  this,  that  taxation  shall  not  be  arbitrary,  capricious,  or 
plainly  unreasonable  and  that  within  each  class  of  persons  or 
objects  the  burden  shall  be  equal.  (1)  Everywhere  the  legisla- 
ture is  given  a  wide  latitude  in  exempting  property,  so  that  in- 
stitutions and  industries  which  are  regarded  as  of  peculiar  value 
to  the  people  may  be  encouraged  by  freedom  from  taxation. 
Almost  everywhere,  poll  taxes  which  impose  an  unequal  burden 
upon  the  poor,  liquor  licenses  which  impose  unequal  obligations 
upon  those  who  pay  them,  inheritance  and  corporation  taxes 
which  single  out  particular  classes  of  society  for  unusual  taxa- 
tion, are  sustained  by  the  courts.  Justice  in  taxation,  then, 
does  not  require  rigid  equality  or  narrow  uniformity  of  treatment. 
(2)  Institutions  which  are  socially  harmful  may  be  subject  to 
peculiarly  drastic  and  oppressive  taxation ;  that  is  to  say,  jus- 
tice may  take  into  account  sumptuary  considerations.  (3)  Old 
taxes,  which  would  not  be  used  if  they  were  not  already  in- 
trenched in  the  fiscal  and  social  system,  are  permitted  to  endure ; 
justice  takes  cognizance  of  the  fact  that,  other  things  being  equal, 
an  old  tax  is  a  good  tax  by  very  reason  of  its  age.  (4)  Indirect 
taxes  which  weigh  more  heavily  upon  the  poor  than  the  rich 
show  no  signs  of  disappearing ;  that  is  to  say,  justice  gives  due 
weight  to  the  productivity  of  a  tax,  its  cheapness  of  collection,  and 
convenience  of  payment,  and  balances  these  considerations  against 
factors  which  we  are  accustomed  to  regard  as  more  fundamentally 
ethical.  (5)  Taxes  may  be  employed  to  suppress  state  banks 
of  issue,  protect  home  manufactures,  and  in  general  to  accomplish 
political  and  social  ends  other  than  the  mere  raising  of  revenue. 
Taxation  is  seldom  the  best  agent  of  social  or  political  reform. 
If  there  is  an  evil  which  needs  eradication,  the  best  way  is  to 
suppress  it  directly,  if  possible,  rather  than  discourage  it  a  little 
by  general  taxation.  But  this  does  not  affect  the  general  proposi- 
tion that  where  taxation  is  an  efficient  remedy,  or  the  only  remedy, 
justice  sanctions  its  employment.  (6)  Finally,  it  is  plain  that, 
however  we  strive,  nothing  better  than  approximate  justice  can 
ever  be  secured  in  taxation.     A  system  that  frankly  recognizes 


698  OUTLINES  OF  ECONOMICS 

this  truth  and  makes  for  rough  justice,  by  the  imposition  of  taxes 
which  are  simple,  stable,  convenient,  inexpensive,  and  produc- 
tive, is  far  better  than  one  which  attempts  to  secure  exact  jus- 
tice through  complex  and  delicate  schemes  of  taxation  which 
cannot  be  definitely  or  efficiently  administered. 

3.  The  theory  of  justice  most  widely  accepted  by  American 
courts  at  the  present  time  is  expressed  in  the  maxim  that  taxes 
should  be  proportioned  to  benefits  derived.  Like  other  rules  of 
justice,  this  maxim  contains  elements  of  truth  and  elements  of 
error.  It  is  a  fairly  helpful  guide,  for  instance,  in  dealing  with 
public  revenues  other  than  taxes.  Public  prices,  fees,  and 
special  assessments  should,  as  we  have  seen,  be  proportioned  to 
benefits,  unless  there  is  strong  reason  for  departing  from  the  rule. 
And  in  the  apportionment  of  taxation  among  districts  or  govern- 
mental sections,  the  rule  still  retains,  and  probably  always  will 
retain,  a  large  measure  of  validity.  Taxation,  we  say,  must  per- 
tain to  the  district  taxed,  meaning  by  this  that  under  ordinary 
circumstances  it  is  not  wise  to  tax  District  A  for  the  benefit  of 
District  B ;  although  there  are  important  exceptions  to  this 
rule.  But  in  the  apportionment  of  taxes  among  the  individuals 
of  a  given  district,  the  rule  has  little  or  no  place.  This  conclu- 
sion follows,  if  for  no  other  reason,  from  our  definition  of  the 
word  "  taxes,"  which  we  confine  to  contributions  levied  with- 
out reference  to  special  benefits  received,  either  because  no 
special  benefit  can  be  assigned,  or  because  (as  in  the  case  of 
free  schools)  we  specifically  desire  to  lift  the  cost  of  the  service 
from  the  shoulders  of  some  of  those  who  specially  benefit  by  the 
service.  Moreover,  in  general,  it  is  impracticable  to  determine 
what  proportion  of  the  general  benefits  of  government  accrue  to 
particular  individuals. 

4.  At  the  present  time  a  great  majority  of  economists  agree 
that  taxes  should  be  apportioned  according  to  "  faculty  "  or 
ability  to  pay.  It  must  be  confessed  that  the  rule  is  not  very 
satisfactory.  No  simple  measure  of  ability  exists,  and  many 
taxes,  which  under  a  superficial  examination  seem  to  conform 
to  the  rule,  such  as  the  general  property  or  income  tax,  are  found 
upon  closer  examination  to  violate   the   rule  in  many  wavs. 


PUBLIC   RECEIPTS  699 

Despite  all  these  defects,  however,  the  ability  principle  has  ele- 
ments of  great  strength.  It  satisfies  our  sense  of  justice,  in  the 
first  place,  when  explicit  reasons  cannot  be  given  for  departing 
from  a  general  rule;  and  it  expresses  the  ideal  towards  which 
we  strive  in  voluntary  contributions  to  the  church  or  other 
voluntary  joint  enterprises  of  a  social  nature.  In  the  second 
place,  we  can  frequently  ascertain  with  certainty  that  the  rule 
is  being  violated,  when  we  cannot  define  its  meaning  positively, 
and  hence  it  is  capable  of  practical  application  in  a  negative 
way.  We  may  therefore  accept  the  rule  in  this  sense,  that  un- 
less other  treatment  is  justified  by  the  considerations  cited  in 
paragraph  2,  above,  or  by  analogous  reasons,  no  tax  which  is 
plainly  disproportional  to  the  ability  of  the  contributors  should 
be  employed. 

5.  Accepting  the  ability  principle  as  the  best  rule  for  general 
taxes  as  distinguished  from  the  specific  taxes  noted  in  para- 
graph 2,  we  at  once  encounter  the  difficult  question,  how  is  ability 
to  be  measured?  Different  writers  have  recommended  as  the 
basis  or  measure  of  ability,  income,  outgo  or  consumption,  and 
property.  A  little  cons'deration  will  convince  the  reader  that 
each  of  these  measures  is  marked  by  minor  defects.  The  con- 
sumption of  the  poor,  for  instance,  is  out  of  all  proportion  to  their 
ability  to  bear  the  burdens  of  the  state.  Property,  on  the  other 
hand,  differs  widely  in  its  productiveness,  and,  moreover,  many 
persons  with  a  little  property  have  large  incomes,  and  therefore 
great  ability  to  bear  taxation.  Incomes,  similarly,  differ  in  per- 
manence and  security,  and  equal  incomes  are  called  upon  to 
support  very  unequal  numbers  of  persons.  Fortunately,  it  is 
not  imperative  in  practice  to  make  a  decision  between  these 
measures  of  ability.  The  necessities  of  fiscal  administration 
make  it  imperative  in  actual  practice  to  employ  all  three  bases 
of  taxation.  Property,  consumption,  and  income  are  all  em- 
ployed in  the  United  States  at  the  present  time  and  will  un- 
questionably continue  to  be  employed  for  many  generations. 

Progressive  Taxation.  —  After  we  adopt  any  concrete  measure 
of  ability,  we  soon  realize  that  it  is  only  approximately  correct, 
because  we  are  immediately  confronted  with  the  question : 


700  OUTLINES  OF  ECONOMICS 

Does  ability  increase  in  direct  proportion  or  more  rapidly  than 
our  measure  of  ability;  in  other  words,  shall  taxes  be  laid  in 
direct  proportion  to  income,  property,  etc.,  or  shall  the  rate  be 
increased  as  the  amount  of  income  or  property  increases  ?  The 
first  method  is  called  proportional  taxation,  the  second  progres- 
sive or  graduated.  If  the  rate  diminishes  as  the  income  or 
property  increases,  we  speak  of  it  as  regressive  taxation;  and 
if  the  rate  increases  faster  than  the  income  or  property,  but 
toward  a  fixed  limit  which  it  can  never  exceed,  it  is  referred  to  as 
degressive  taxation.  The  last  kind  of  rating  is  of  course  a  special 
variety  of  progressive  taxation,  and  usually  results  from  the 
combination  of  a  nominally  proportional  rate  with  the  exemp- 
tion of  a  fixed  sum  from  all  incomes  or  assessed  wealth.  The 
American  property  tax  is  in  principle  a  degressive  tax,  though 
it  is  regressive  in  practical  effect. 

From  the  theoretical  standpoint  our  real  knowledge  upon  this 
subject  is  exceedingly  unsatisfactory.  On  the  whole,  the  argu- 
ments of  those  who  approve  progressive  taxation  are  more  con- 
vincing than  those  of  its  opponents,  and  a  majority  of  economists 
at  the  present  time  agree  in  asserting  that  ability  increases  faster 
than  income,  property,  or  any  common  measure  of  ability.  If 
we  construe  ability  as  ability  to  bear  sacrifice  (as  John  Stuart 
Mill  and  some  other  authorities  do)  and  confine  our  attention 
solely  to  the  consumer,  there  can  be  no  doubt  that  progressive 
taxation  is  the  means  by  which  the  least  sacrifice  will  be  visited 
upon  the  community  as  a  whole.1  This  is  a  strong  argument, 
because  one  of  the  chief  immediate  effects  of  taxation  is  to  de- 
prive persons  of  the  necessaries,  conveniences,  and  luxuries  of 
life,  while  the  maxim  of  the  greatest  good  to  the  greatest  number 
—  or  as  it  works  out  in  taxation,  the  least  sacrifice  to  the  least 
number  —  is  one  of  the  most  widely  accepted  rules  of  social 
conduct.  Surveying  the  ability  theory  from  the  positive  stand- 
point of  ability  to  acquire  or  produce  property,  we  find  the  testi- 
mony almost  universal,  that  as  the  fortune  or  income  increases, 
the  ability  to  earn  or  produce  more  increases  at  an  accelerating 
pace.     "  It  is  the  first  thousand  that  counts,"  in  the  language 

1  See  T.  N.  Carver,  Essays  in  Social  Justice,  pp.  401-406. 


PUBLIC   RECEIPTS  701 

c)f  the  successful  man  who  is  telling  the  younger  generation  how 
he  succeeded. 

Coming  to  the  more  concrete  and  more  practical  arguments, 
we  find  that  the  balance  of  opinion  also  inclines  to  the  side  of 
those  who  favor  progressive  taxation.  Let  us  briefly  recapitu- 
late these  arguments  and  attempt  to  estimate  their  net  resultant. 
Those  who  oppose  progressive  taxation  charge  that  the  proposal 
is  socialistic,  that  it  would  discourage  the  accumulation  of 
wealth,  that  it  would  not  be  particularly  productive,  —  mean- 
ing by  this  that  the  element  of  progressivity  adds  little  to  what 
would  be  produced  by  a  proportional  rate,  —  that  it  would 
stimulate  fraud  and  evasion,  that  it  would  interfere  with  the 
device  known  as  "  collection  at  the  source,"  and  that  finally 
the  whole  principle  is  arbitrary  and  capricious  in  the  sense  that 
there  is  no  natural  limit  to  the  increase  of  the  rate. 

To  these  charges  the  defendants  of  progressive  taxation  pre- 
sent plans  1  by  which  collection  at  the  source  and  progressive 
rating  may  be  successfully  combined  in  the  same  system;  and 
reply,  further,  that  terms  are  immaterial  and  questions  cannot 
be  settled  by  bandying  epithets  such  as  "  socialistic,"  "  an- 
archistic," and  the  like ;  that  every  tax  discourages  the  accu- 
mulation of  wealth ;  that  whether  the  tax  will  be  productive  or 
not,  it  will  relieve  the  poorer  classes  to  the  extent  that  the  pro- 
gressive rates  do  actually  fall  upon  the  rich ;  that  persons  ca- 
pable of  evading  their  obligations  to  the  government  will  attempt 
to  evade  proportional  taxes  as  well  as  progressive  taxes;  and 
that  all  taxation  is  more  or  less  arbitrary,  resting  upon  the  judg- 
ment and  common  sense  of  the  legislature.  The  exemptions 
made  in  every  tax  law,  the  size  of  a  license  fee  of  any  kind,  the 
rates  of  excise  and  customs  duties,  are  all  "  arbitrary  "  and  un- 
limited in  the  sense  that  progressive  taxation  is  arbitrary  and 
unlimited.  Finally,  the  defendant  of  progressive  taxation 
points  out  that,  owing  to  the  great  prominence  of  indirect  taxes 
in  our  revenue  system  and  the  tendency  of  assessors  to  assess 
large  properties  at  a  lower  proportion  of  real  value  than  smaller 

1  Report  from  the  Select  [British]  Committee  on  Income  Tax,  1906,  pp.  iii-vii.  Com- 
pare also  the  provisions  of  the  federal  income  tax. 


702  OUTLINES   OF   ECONOMICS 

properties,  American  taxation  today  is  in  practice  regressive, 
and  some  progressivity  is  needed,  if  only  to  balance  the  ad- 
mitted regressivity  of  existing  taxes. 

While  general  considerations  thus  seem  to  warrant  persistent 
effort  to  introduce  a  moderate  measure  of  progressivity  into 
our  direct  taxes,  the  student  is  warned  that  this  should  not  be 
done  in  any  doctrinaire  or  offhand  fashion.  A  thousand  con- 
siderations of  practical  expediency  must  be  taken  into  account 
in  the  shaping  of  a  revenue  system,  and  in  the  end  we  are  more 
likely  to  attain  the  goal  which  the  advocates  of  progressive  taxa- 
tion seek  by  careful  exemptions  from  taxation,  by  special  taxes 
upon  corporations,  monopolies,  inheritances,  and  certain  forms 
of  income,  and  by  directing  expenditures  to  the  succor  of  the  weak 
and  the  equalization  cf  opportunity,  than  by  exclusive  depend- 
ence upon  any  one  far-reaching  tax  such  as  a  progressive  in- 
come or  property  tax. 

No  tax  system,  then,  can  be  fairly  judged  without  reference 
to  the  character  Of  expenditures.  Where  the  expenditures  are 
wasteful,  corrupt,  and  unwise,  heavy  taxation  is  a  curse,  —  al- 
though even  here  the  rational  method  of  reform  is  rather  to 
root  out  the  corruption  and  improve  the  administration,  than 
to  reduce  taxation,  even  if  temporarily  it  may  be  wise  to  do 
the  latter.  But  where  the  expenditures  are  on  the  whole 
wisely  and  beneficently  made,  heavy  taxation  is  not  an  evil. 
No  country  was  ever  yet  ruined  by  large  expenditures  of  money 
by  the  public  and  for  the  public.  The  true  principle  to  be  ob- 
served in  levying  taxes  was  tersely  expressed  in  the  41st  section  of 
the  constitution  adopted  by  Pennsylvania  in  1776  :  "  No  public 
tax,  custom,  or  contribution  shall  be  imposed  upon,  or  paid  by, 
the  people  of  this  state,  except  by  a  law  for  that  purpose ;  and 
before  any  law  be  made  for  raising  it,  the  purpose  for  which 
any  tax  is  to  be  raised  ought  to  appear  clearly  to  the  legislature 
to  be  of  more  service  to  the  community  than  the  money  would 
be  if  not  collected,  which  being  well  observed,  taxes  can  never 
be  burthens." 

Direct  and  Indirect  Taxes.  —  The  considerations  just  adduced 
have  an  important  bearing  upon  a  problem  which  will  probably 


PUBLIC   RECEIPTS  703 

become  acute  in  the  near  future :  the  question  of  raising  addi- 
tional revenue  by  indirect  taxation.  Indirect  taxes  have  been 
strongly  condemned  by  many  authorities  in  the  past,  largely 
because  they  weigh  more  heavily  upon  the  poor  than  the  rich. 
But  if  we  are  to  finance  successfully  a  double  program  of  mili- 
tary preparedness  and  social  insurance  in  the  future,  it  will 
probably  be  necessary  not  only  to  keep  most  of  the  indirect 
taxes  which  we  now  have,  but  to  adopt  others.  There  are  prac- 
tical limits  to  direct  taxation  in  every  country.  Pushed  be- 
yond a  certain  point,  direct  taxes  discourage  both  saving  and 
business  enterprise.  Many  of  them  —  although  the  income  tax 
is  a  marked  exception  —  fall  upon  the  taxpayer  in  lean  years 
as  well  as  in  prosperous  years,  and  must  be  paid  even  though  the 
money  to  pay  them  has  to  be  borrowed  by  the  taxpayer.  In- 
direct taxes,  on  the  other  hand,  are  usually  paid  in  small  driblets 
and  there  is,  in  their  payment,  a  voluntary  element  which  makes 
them  easier  to  bear.  The  person  who  elects  to  drink  beer  may 
pay  proportionally  a  large  indirect  tax,  but  he  is  not  compelled 
to  drink  beer.  Moreover,  indirect  taxes  may  be  levied  upon 
articles  of  luxury  and  other  commodities  consumed  predomi- 
nantly by  the  wealthier  classes,  so  as  to  operate  as  progressive 
rather  than  regressive  taxes,  when  considered  from  a  broad 
social  standpoint.  Finally,  even  regressive  taxes  may  be 
helpful  to  the  poorer  classes  if  public  expenditures  are  directed  in 
sufficient  volume  to  the  support  of  education,  social  insurance,  and 
theequalization  of  opportunity.  It  is  more  important  that  expend- 
itures should  be  progressive  in  their  social  incidence  than  it  is  to 
collect  taxes  in  accordance  with  schedules  of  progressive  rates. 

The  Shifting  of  Taxes.  —  Up  to  this  point  we  have  been  speak- 
ing as  if  a  tax  must  remain  where  it  is  originally  placed.  This 
we  know  is  not  always  the  case.  Excise  taxes,  for  instance,  are 
usually  levied  with  the  expectation  that  they  will  be  passed  or 
shifted  from  the  business  man,  who  first  pays  them,  to  the  con- 
sumer or  some  other  person.  The  conditions  which  control  the 
shifting  of  taxes  must  evidently  be  considered  —  at  least  in  a 
very  general  way  —  before  we  discuss  the  practical  working  of 
the  American  system  of  taxations. 


704  OUTLINES  OF  ECONOMICS 

The  word  "  shifting  "  usually  refers  to  the  increase  of  price 
by  which  the  original  payer  of  the  tax  attempts  to  recoup  him- 
self. This  increase  of  price  is  usually  accompanied  by  collateral 
economic  disturbances  or  dislocations  —  suggested  by  the  phrase 
"  repercussion  of  taxes  "  which  is  frequently  employed  in  this 
connection  —  that  are  quite  as  important  as  the  mere  change  in 
price.  For  instance,  an  excise  tax  (per  unit  of  product)  upon  a 
monopoly  may  raise  the  price  by  as  much  or  even  more  than 
the  tax  itself.  But  the  monopolist  nevertheless  feels  the  burden 
of  the  tax  in  reduced  profits.  When  we  say  that  a  tax  is  shifted, 
then,  we  do  not  imply  that  the  original  payer  evades  all  the 
evil  effects  of  the  tax. 

Mobility  is  the  chief  factor  which  controls  shifting ;  and  this 
in  turn  is  largely  dependent  upon  the  inclusiveness  or  scope  of 
the  tax,  and  upon  the  existence  of  monopoly  or  differential  ad- 
vantages. Place  a  tax  upon  a  person  or  thing  which  can  easily 
move  to  a  jurisdiction  where  such  taxes  are  not  imposed,  and 
the  tax  is  very  likely  to  be  shifted.  Local  taxes  upon  mortgage 
loans  offer  a  good  example.  Such  taxes  are  very  likely  to  raise 
the  interest  rate  by  as  much  or  a  little  more  than  the  tax  rate, 
the  "  little  more  "  being  explained  by  the  trouble  imposed  upon 
the  lender  in  looking  after  the  tax  and  the  risk  that  the  tax  rate 
will  be  increased.  On  the  other  hand,  if  mortgage  lenders  are 
constrained  by  ignorance  or  custom  or  the  existence  of  particu- 
larly high  rates  in  this  district  to  keep  on  supplying  the  old 
amounts  of  loans,  the  tax  will  not  be  shifted.  Unless  the  supply 
can  be  or  is  reduced  by  the  tax,  shifting  will  not  ordinarily  take 
place. 

Naturally,  therefore,  the  particular  nature  of  the  supply  is  of 
prime  importance.  We  may  illustrate  by  an  excise  tax  per  unit 
of  product  upon  competitive  industries  of  various  kinds.  In 
industries  subject  to  the  law  of  constant  expense,  a  fixed  tax  per 
unit  of  product  will  raise  the  price  by  just  the  amount  of  the  tax, 
in  theory.  In  industries  subject  to  the  law  of  increasing  expense, 
however,  the  reduction  of  the  supply  caused  by  the  tax  some- 
what reduces  the  expenses  of  production  per  unit  exclusive  of 
the  tax,  and  on  this  account  prices  in  such  industries  will  in- 


PUBLIC   RECEIPTS  705 

crease  by  an  amount  less  than  the  tax.  In  industries  subject  to 
the  law  of  diminishing  expense,  on  the  other  hand,  the  price  will 
be  raised  by  an  amount  equal  to  the  tax,  plus  an  amount  equal 
to  the  increased  expense  of  production  caused  by  the  limitation 
of  supply. 

Mobility,  as  has  been  said,  is  the  most  important  factor  in  this 
connection,  and  it  may  be  restricted  or  destroyed  in  a  variety 
of  ways.  Monopoly  limits  mobility,  and,  as  we  have  already 
seen,1  the  monopolist  cannot  shift  a  fixed  tax  or  a  proportional 
tax  on  net  profits  unless  the  tax  is  so  high  as  to  reduce  monopoly 
profits  below  the  amount  that  could  be  earned  on  the  same  in- 
vestment in  a  competitive  industry.  For  somewhat  similar, 
but  not  exactly  the  same  reasons,  differential  gains  from  durable 
property  are  peculiarly  susceptible  to  taxation.  Thus,  econo- 
mists generally  indorse  the  proposition  that  a  tax  on  economic 
rent  falls  upon  the  landlord  and  cannot  be  shifted.  The  validity 
of  this  depends  both  upon  the  durability  of  land  and  the  fact 
that  the  tax  is  levied  upon  a  differential  clement.  If  land  wore 
out  and  had  to  be  replenished,  the  tax  would  reduce  the  future 
supply  of  land  and  hence  raise  its  price  and  its  rent  in  the  future. 
Similarly,  if  the  tax  were  levied  upon  the  product  of  marginal  or 
no-rent  land,  it  would  elevate  the  margin,  reduce  the  supply  of 
those  products  or  services  which  land  affords,  and  in  this  way 
again  raise  prices  and  partially  reimburse  the  landlord.  But, 
by  hypothesis,  neither  of  these  suppositions  is  true.  Land, 
as  we  define  it,  does  not  wear  out ;  and  at  the  margin  land  yields 
no  economic  rent. 

The  proposition  that  a  tax  on  economic  rent  cannot  be  shifted 
is  true,  moreover,  only  of  a  proportional  tax.  A  tax  of  so  much 
per  bushel  or  pound  upon  agricultural  produce  would  move  the 
margin  of  cultivation  and  thus  affect  prices.  Indeed,  the  exact 
form  of  a  tax  —  whether  fixed,  proportional,  or  progressive,  upon 
net  or  gross  returns,  upon  product  or  upon  profit  —  is  of  funda- 
mental importance  always.  Generally  speaking,  proportional 
taxes  upon  net  income  are  less  easily  shifted  than  other  forms  of 
taxes. 

1  Pp.  202, 203. 


7c6  OUTLINES  OF  ECONOMICS 

If  the  object  of  taxation  be  durable  and  the  tax  a  special  or 
exclusive  one,  the  price  of  the  object  is  likely  to  be  reduced  by 
an  amount  equal  to  the  capitalized  value  of  the  tax.  Prospec- 
tive purchasers  of  land  take  into  account  the  taxes  that  are  likely 
to  be  levied  upon  it,  capitalize  these,  and  subtract  their  capital- 
ized value  from  the  amount  which  they  would  pay  for  the 
property  if  it  were  not  liable  to  taxation.  The  apparent  result 
of  this  capitalization  or  amortization  of  taxes,  as  the  process  is 
called,  is  to  place  the  burden  of  an  endless  succession  of  taxes 
upon  the  original  owner,  and  relieve  subsequent  purchasers  of 
any  real  burden. 

Many  present-day  followers  of  Henry  George  find  in  this  prin- 
ciple of  amortization  at  once  a  justification  and  a  method  of 
securing  for  society  all  economic  rent.  Under  present  condi- 
tions, they  say,  a  man  who  buys  land  wholly  escapes  taxation 
upon  it.  Consequently,  in  order  to  make  landowners  pay  as 
much  as  other  people  we  should  have  to  increase  the  tax  upon 
land  by  a  rate  equal  to  that  paid  by  the  average  tax-payer  as 
often  —  say  every  thirty  years  —  as  the  land  of  the  community 
changes  holders.  In  this  way  the  State  could  gradually  and  with 
justice  absorb  all  economic  rent.1 

But  this  whole  chain  of  reasoning  is  fallacious  for  three 
reasons:  (i)  What  the  prospective  purchaser  capitalizes  and 
deducts  is  not  the  entire  tax  on  the  land,  but  the  excess  of  that 
tax  over  similar  taxes  upon  other  investments  open  to  him.  A 
new  purchaser  of  land  does  not  "  buy  free  of  taxes,"  as  is  so 
often  stated;  what  he  does  is  to  buy  free  of  any  excessive  or 
abnormal  tax  burden.  After  the  purchase  he  not  only  pays 
taxes  in  appearance,  but  in  actual  fact  pays  the  average  tax 
rate.  (2)  In  so  far  as  this  program  of  the  single  taxers  was 
anticipated  and  understood,  it  would  visit  the  whole  burden  of 
the  "  reform  "  upon  present  owners,  instead  of  being  distributed 
over  several  generations.  Subsequent  purchasers  would  dis- 
count these  periodic  increases  of  the  tax  and  pay  to  owners  for 
their  land  only  the  present  value  of  the  rapidly  vanishing  income 

1  See  the  paper  upon  "The  Single  Tax"  by  C.  B.  Fillebrown  in  State  and  Loc:l 
Taxation  (Proceedings  of  the  National  Tax  Association),  vol.  i,  pp.  286-293. 


PUBLIC   RECEIPTS  707 

from  land.  Land  would  be  valued  as  a  terminable  annuity. 
(3)  This  whole  doctrine  overlooks  the  inevitable  consequence 
that,  if  "  the  selling  value  of  land  is  an  untaxed  value  "  and 
if  "  the  burden  of  a  land  tax  cannot  be  made  to  survive  a  change 
of  ownership,"  these  facts  would  so  increase  the  demand  for 
land  that  the  profits  from  its  purchase  and  ownership  would 
not  exceed  profits  in  other  lines  of  investment.  Given  plenty 
of  time,  active  competition,  together  with  a  knowledge  of  the 
facts  of  the  situation,  and  such  inequalities  of  taxation  are  in- 
evitably smoothed  out  by  the  natural  movement  of  capital 
toward  the  taxless  field  or  away  from  the  field  in  which  burdens 
are  particularly  severe. 

This  inevitable  reckoning  of  taxation  among  the  disadj 
vantages  of  industry  brings  it  to  pass  that  many  old  taxes  are 
diffused  over  the  entire  community.  Such  diffusion  does  not  take 
place  when  the  nature  of  the  supply  prevents  it  from  varying 
in  nice  correspondence  with  the  prospects  of  profit.  A  poll  tax 
upon  laborers,  for  instance,  will  in  our  opinion  not  be  shifted,  as 
it  is  likely  to  lower  their  standard  of  living,  stimulate  the  birth 
rate,  and  in  turn  (other  things  being  equal)  actually  reduce 
wages.  But  exclusive  taxes  on  capital  and  business  will  be 
diffused ;  and  for  this  reason  there  is  a  profound  practical  truth 
in  the  famous  dictum  of  Canard  that  "  every  old  tax  is  good; 
every  new  tax  is  bad,"  when  sympathetically  interpreted.  Of 
course  this  doctrine  assumes  that  industrial  changes  are  infre- 
quent. The  tax  system  must  and  should  vary  with  changes  in 
the  fortunes  of  business  enterprise.  The  development  of  a  new 
industry  making  unusual  and  unexpected  profits  offers  a  good 
opportunity  of  relieving  an  old  industry  that  has  unexpectedly 
fallen  upon  evil  days.  And  for  this  reason  it  is  highly  desirable 
that  state  constitutions  prescribing  a  rigidly  uniform  system  of 
taxation  should  be  amended  so  as  to  permit  reasonable  classifica- 
tion of  property  and  business  for  purposes  of  taxation.  All  these 
qualifications  of  the  diffusion  theory  are  true  and  important. 
But  the  fact  still  remains  that  under  ordinary  conditions  noth- 
ing is  worse  in  a  tax  system  than  uncertainty,  continual  tinker- 
ing with  rates,  and  capricious  readjustment  of  methods. 


708  OUTLINES  OF  ECONOMICS 

QUESTIONS  AND  EXERCISES 

i.  In  accordance  with  what  principles  of  classification  do  we  distinguish 
fees,  special  assessments,  and  taxes? 

2.  Enumerate  six  fees  commonly  employed  by  state  governments. 

3.  What  accounts  for  the  rapid  development  of  the  special  assessment  in 
the  last  fifty  years  ?  Is  it  possible  to  apportion  the  benefits  of  a  public  im- 
provement with  any  degree  of  accuracy? 

4.  Why  are  liquor  licenses  distinguished  from  other  licenses  and  permits  ? 

5.  Has  the  state  a  greater  right  to  tax  land  and  natural  agents  than 
produced  wealth  ? 

6.  May  monopolies  be  equitably  subjected  to  special  taxation?  Even 
if  the  monopoly  rests  upon  superior  efficiency,  or  upon  patent  rights  justly 
acquired  ? 

7.  Is  rigid  equality  of  taxation  a  primary  and  fundamental  desideratum  ? 
Is  it  possible  of  achievement?  Is  there  any  real  distinction  between  the 
so-called  ethical  qualities  (of  equality,  uniformity,  etc.)  and  the  so-called  ad- 
ministrative qualities  (convenience,  elasticity,  productivity,  etc.)  of  a  tax? 

8.  Is  the  benefit  principle  wrong  or  merely  impossible  of  application? 
If  wrong,  why  do  we  retain  it  in  fees  and  special  assessments? 

9.  Is  it  easier  to  measure  ability  than  benefits? 

10.  Is  progressive  taxation  arbitrary?  Can  it  be  satisfactorily  con- 
sidered apart  from  the  effect  of  public  expenditures  ? 

n.  Work  out  the  effect  of  an  excise  tax  on  a  monopoly  subject  to  the  law 
of  increasing  expense. 

12.  Do  people  buy  land  " free  of  taxes " ?  If  so,  why  does  not  everyone 
buy  land  in  Order  to  escape  taxation  ? 

13.  Can  our  state  legislatures  be  trusted  to  "classify"  property  for  taxa- 
tion fairly  and  impartially?  State  the  arguments  for  and  against  repealing 
the  uniformity  provisions  common  in  state  constitutions. 

REFERENCES 

Bastable,  C.  F.     Public  Finance,  Book  iii,  Chaps,  iii,  v,  and  vii. 

Carver,  T.  N.    Essays  in  Social  Justice,  Chap.  xvii. 

Cooley,  T.  M.    A  Treatise  on  the  Law  of  Taxation  (3d  ed.),  Chaps,  ii  and  vi. 

Ely,  R.  T.     Taxation  in  American  States  and  Cities,  Part  i,  Chap.  iii. 

Fillebrovvn,  C.  B.     Taxation. 

Gray,  J.  M.    Limitation  of  Taxing  Power  on  Public  Indebtedness,  pp.  25-54, 

642-915. 
Jones,  Robert.     The  Nature  and  First  Principles  of  Taxation. 
Judson,  F.  N.     A  Treatise  on  the  Power  of  Taxation. 
Lyon,  Hastings.    Principles  of  Taxation. 
National  Tax  Association.    Proceedings  of  the  National  Conferences  (formerly 

Slate  and  Local  Taxation). 


PUBLIC   RECEIPTS  709 

Patterson,  E.  M.  (editor),  "Readjustments  in  Taxation,"  Annals  of  the 

American  Academy  of  Political  and  Social  Science,  Vol.  lviii. 
Plehn,  C.  C.    Government  Finance  in  the  United  Slates. 
Post,  L.  F.     The  Taxation  of  Land  Values. 
Rosewater, Victor,  "Special  Assessments :  a  Study  in  Municipal  Finance," 

Columbia  University  Studies  in  History,  Economics,  and  Public  Law, 

Vol.  ii,  No.  3. 
Seligman,  E.  R.  A.     The  Shifting  and  Incidence  of  Taxation,  Part  ii,  Chap,  i ; 

Progressive  Taxation  in  Theory  and  Practice,  Part  ii,  Chap,  iv,  and 

Part  iii. 
Urdahl,  T.  K.     "The  Fee  System  in  the  United  States,"  Transactions  of 

the  Wisconsin  Academy  of  Science,  Arts,  and  Letters,  Vol.  xii,  Part  i,  pp. 

49-67,  210-230. 
Weston,  S.  F.     "Principles  of  Justice  in  Taxation,"  Columbia  University 

Studies  in  History,  Economics,  and  Public  Law,  Vol.  xvii,  No.  2. 


CHAPTER  XXXIV 
FEDERAL,   STATE,   AND   LOCAL   TAXES 

Federal  Taxation 

Constitutional  Limitations.  —  The  fundamental  character  of 
the  American  revenue  system  is  determined  by  those  clauses  of 
the  federal  constitution  which  provide  that  "  direct  taxes  shall 
be  apportioned  among  the  several  states  .  .  .  according  to  their 
respective  numbers  " ;  that  "  all  duties,  imposts,  and  excises 
shall  be  uniform  throughout  the  United  States  "  ;  and  that  "  no 
state  shall,  without  the  consent  of  Congress,  levy  any  imposts  or 
duties  on  imports  or  exports,  except  what  may  be  absolutely 
necessary  for  executing  its  inspection  laws." 

Just  what  the  words  duties,  imposts,  excises,  direct  and  in- 
direct taxes  signify,  as  used  in  the  constitution,  has  been  a  matter 
of  considerable  discussion.  Ordinarily  the  word  duty  "  means 
an  indirect  tax  imposed  upon  the  importation,  exportation,  or 
consumption  of  goods,"  being  given  "  a  broader  meaning  than 
custom,  which  is  a  duty  imposed  upon  imports  or  exports,"  while 
"  the  term  impost  also  signifies  any  tax,  tribute,  or  duty,  but  it 
seldom  applied  to  any  but  indirect  taxes.  An  excise  duty  is  an 
inland  impost  levied  upon  articles  of  manufacture  or  sale,  and 
also  upon  licenses  to  pursue  certain  trades  or  to  deal  in  certain 
commodities." 

All  these  differences  turn  largely  upon  the  meaning  of  the 
words  direct  and  indirect  taxes.  According  to  most  economists 
direct  taxes  are  taxes  levied  by  the  state  upon  those  who  are 
expected  to  bear  their  burden,  while  indirect  taxes  are  supposed 
to  be  shifted  to  others.  In  the  economic  sense,  therefore,  poll 
taxes,  property,  income,  and  inheritance  taxes  are  usually 
called  direct,  while  customs  taxes  and  excise  taxes  are  called 


FEDERAL,  STATE,  AND   LOCAL  TAXES  71 1 

indirect.  It  is  plain  that  the  economic  meaning  of  these  words 
is  exceedingly  vague,  because  it  is  made  to  turn  upon  expecta- 
tions concerning  the  shifting  of  taxes,  and  upon  few  subjects 
is  there  more  uncertainty  than  upon  this.  Economists  have 
generally  protested  against  any  employment  of  these  terms  in 
scientific  analysis,  and  where,  because  of  their  frequent  em- 
ployment both  in  popular  discussion  and  statute  law,  it  has 
been  necessary  to  retain  them,  they  have  tried  to  introduce  a 
more  consistent  usage. 

Owing  to  the  practical  impossibility  of  maintaining  a  logical 
distinction  between  direct  and  indirect  taxes  based  upon  eco- 
nomic principles,  it  was  commonly  thought  until  the  latter  part 
of  the  nineteenth  century  that  it  was  necessary  to  give  these 
terms  a  strictly  historical  interpretation,  based  upon  usage  cur- 
rent in  this  country  at  the  time  the  constitution  was  adopted. 
Accordingly,  capitation  and  land  taxes  were  generally  believed 
to  be  the  only  forms  of  direct  taxes.  This  belief  was  partly  due 
to  the  fact  that  the  federal  Supreme  Court  at  various  times 
had  sanctioned  the  use  by  the  federal  government  of  income, 
inheritance,  and  specific  property  or  consumption  taxes. 

In  the  famous  Pollock  x  case,  however,  the  Supreme  Court 
rendered  a  decision  in  1895  which  was  generally  interpreted  to 
hold  that  income  taxes,  so  far  as  they  include  income  from  real 
estate  and  some  other  forms  of  property,  are  direct  taxes. 
Nevertheless,  what  was  practically  an  income  tax  upon  cor- 
porations was  adopted  in  1909.  It  was  justified  by  the  Supreme 
Court  as  an  excise  tax,  but  the  principal  difference  between  this 
excise  tax  and  an  income  tax  proper  appears  to  have  been  the 
fact  that,  instead  of  being  levied  upon  or  on  income,  it  was  levied 
and  assessed  "  with  respect  to  "  or  in  accordance  with  income.2 

1  Pollock  v.  Farmers'  Loan  and  Trust  Co.,  157  U.  S.  429;   158  U.  S.  601. 

2  At  a  later  date  (January  24,  1916)  in  the  case  of  Brushaber  vs.  Union  Pacific 
Railroad  Company,  the  Supreme  Court  upheld  the  constitutionality  of  the  present 
federal  income  tax  law  and  Chief  Justice  White  took  occasion  to  expound  the  tangled 
meaning  of  the  famous  Pollock  decision.  He  announced  that  "the  conclusion 
reached  in  the  Pollock  case  did  not  in  any  degree  involve  holding  that  income  taxes 
generically  and  necessarily  came  within  the  class  of  direct  taxes  on  property,  but,  on 
the  contrary,  recognized  the  fact  that  taxation  on  income  was  in  its  nature  an 


712  OUTLINES  OF  ECONOMICS 

finally  in  191 2  the  sixteenth  amendment  to  the  federal  con- 
stitution was  ratified,  which  provides :  "  The  Congress  shall 
have  power  to  lay  and  collect  taxes  on  incomes,  from  whatever 
source  derived,  without  apportionment  among  the  several 
states,  and  without  regard  to  any  census  or  enumeration." 

The  troublous  history  of  the  federal  income  tax  has  been 
briefly  traced  because  it  illustrates  clearly  the  conditions  under 
which  the  American  people  must  frame  and  administer  tax  laws. 
Income  taxes  were  introduced  during  the  Civil  War  and  millions 
of  revenue  collected  under  them  before  their  repeal  in  the  early 
seventies.  When  revived  in  1894  the  income  tax  was  invali- 
dated by  the  Supreme  Court  in  a  decision  which  had  momentous 
political  consequences.  The  adverse  decision  was  then,  by  a 
play  of  words,  evaded  in  the  corporation  excise  tax ;  and  later 
the  entire  principle  was  legitimatized  by  the  sixteenth  amend- 
ment. Finally,  the  Supreme  Court  decided  that  the  income 
tax  is  not  a  direct  tax,  but  under  certain  circumstances  acts 
substantially  like  a  direct  tax.  Nothing  could  illustrate  more 
clearly  the  metaphysical  complexities  introduced  into  tax  legis- 
lation by  constitutional  limitations  whose  final  interpretation 
rests  not  with  the  legislature  but  the  courts.  Much  may  be 
said  for  the  necessity  of  such  constitutional  restrictions  under 
the  American  form  of  government,  but  none  can  deny  the  enor- 
mous difficulties  which  they  throw  in  the  way  of  consistent, 
simple,  and  wise  tax  legislation. 

Use  of  Direct  Taxes  by  the  Federal  Government.  —  Until 
the  twentieth  century,  the  constitutional  limitations  which  we 
have  been  discussing  served  to  concentrate  federal  taxation 
almost  wholly  upon  consumption,  since  direct  taxes  when  appor- 
tioned according  to  population  have  shown  themselves  to  be 
unjust,  unproductive,  and  exceedingly  difficult  of  collection. 
Congress  has  made  use  of  direct  taxes  only  five  times  during  the 
history  of  the  national  government.  Two  million  dollars  was 
apportioned  in  1798;  $3,000,000  in  1813 ;  $6,000,000  in  1815; 

excise  .  .  ."  and  was  invalid  only  because  it  acted  enough  like  a  direct  tax  in  prac- 
tical effect  to  be  subject  to  the  requirement  of  apportionment  according  to 
population. 


FEDERAL,   STATE,   AND   LOCAL  TAXES  713 

$3,000,000  in  1 816;  and  $20,000,000  in  1861.  Except  in  the 
tax  of  1798,  Congress  has  always  permitted  any  state  to  assume 
its  quota  and  raise  the  money  as  it  saw  fit,  although  provision 
was  always  made  for  its  collection  by  federal  officers,  in  case 
the  quota  was  not  assumed  by  the  state  government.  It  would 
be  difficult  to  exaggerate  the  unsatisfactory  character  of  such 
taxation.  In  no  case  has  the  federal  government  ever  collected 
the  full  amount  of  the  tax.  The  taxes  levied  in  1814-1816  con- 
tinued to  be  collected  until  1839.  The  last  payments  on  the 
direct  tax  of  1861  were  not  received  until  1888;  and  in  1891  a 
law  was  passed  abolishing  further  collections  and  authorizing 
the  amounts  which  had  been  collected  under  the  act  of  1861  to 
be  returned.  Considerable  scandal  arose  out  of  this  refunding 
act,  owing  to  the  enormous  commissions  paid  to  certain  lobbyists 
for  their  work  at  Washington  in  securing  the  passage  of  the  law. 
Until  the  adoption  of  the  sixteenth  amendment,  therefore,  the 
federal  government  relied  almost  exclusively,  in  ordinary  years, 
upon  customs  duties,  excises,  and  similar  taxes. 

Customs  Duties.  —  Among  federal  revenues,  customs  duties 
held  the  place  of  first  importance  until  very  recently.  From  the 
foundation  of  the  federal  government  in  1789  until  the  Civil 
War,  with  the  exception  of  a  few  excise  taxes  collected  between 
1 791  and  1802,  the  federal  government  derived  nearly  all  its 
permanent  regular  revenues  from  customs  taxation,  and  since 
the  Civil  War  considerably  more  than  50  per  cent  of  the  per- 
manent revenue  has,  on  the  average,  been  derived  from  this 
source.  From  the  very  beginning,  moreover,  our  customs  duties 
have  been  in  spirit,  if  not  always  in  effect,  protective ;  and  it 
thus  becomes  necessary  to  consider  the  connection  between  the 
protective  and  revenue  principles,  in  addition  to  the  more 
strictly  fiscal  aspects  of  customs  duties. 

Protective  duties  are  imposed  in  the  hope  of  diminishing  im- 
ports and  substituting  in  their  stead  the  products  of  home  manu- 
facturers. To  the  extent,  therefore,  that  they  are  successful  in 
their  purpose,  they  reduce  the  customs  revenues  and  justify  the 
statement  that  there  is  a  fundamental  antagonism  between  the 
protective  and  revenue  principles.     However,  the  reduction  of 


714  OUTLINES  OF  ECONOMICS 

importation  does  not  signify  that  the  consumers  of  the  article  in 
question  are  not  taxed.  So  long  as  the  price  remains  higher 
than  it  would  be  if  no  duty  were  imposed,  the  people  are  taxed 
to  the  extent  of  the  difference,  the  proceeds  of  the  tax  going  to 
home  manufacturers  in  the  form  of  an  unmeasured,  unregulated 
bounty,  whose  burden  upon  the  taxpayers  is  no  less  real  because 
unperceived. 

It  is  equally  evident  that  no  protection  is  given  unless  the  price 
is  raised.  The  popularity  of  customs  duties  is  largely  explained 
by  the  belief  that  the  foreigner  can  be  made  to  bear  the  burden 
of  the  tax.  He  can  in  some  cases,  but  not  in  the  majority  of 
cases.  For  the  most  part  it  is  very  certain  that  the  burden  must 
be  borne  by  the  home  consumer.  But  whatever  the  extent  to 
which  the  foreigner  can  be  made  to  pay  the  tax,  to  that  extent 
the  tariff  fails  to  replace  foreign  by  home  products ;  in  short, 
fails  to  "  protect."  We  cannot  have  our  cake  and  eat  it  too. 
The  more  the  protection  or  bounty  to  the  home  manufacturers, 
the  greater  the  tax  upon  the  consumers,  the  less  the  shifting  of 
the  tax  to  the  foreigner,  and  the  less  the  revenue  to  the  home 
government.  The  protectionist  is  logically  deprived  of  the 
time-worn  argument  that  the  foreigner  foots  the  bill. 

The  European  War  has  deeply  impressed  upon  the  people  of 
the  United  States  the  strength  of  the  argument  for  protection 
based  upon  military  grounds  and  briefly  discussed  on  page 
370  above.  It  is  likely,  therefore,  that  we  shall  have  more  and 
not  less  protection  in  the  immediately  ensuing  years,  particu- 
larly for  those  industries  whose  products  are  believed  to  be  in- 
dispensable to  national  security  in  times  of  war.  So  long  as  war 
is  a  real  possibility  there  is  probably  no  logical  rejoinder  to  this 
argument  for  protection  ;  but  at  least  we  should  realize  that  we 
are  paying  for  our  self-sufficiency,  and  that  the  difference 
between  the  cost  of  the  protected  products  and  what  they 
would  cost  if  imported  from  foreign  countries,  represents  an 
additional  item  in  the  budget  of  "  preparedness  "  which  has 
already  reached  colossal  proportions. 

The  shifting  of  import  duties  may  be  best  explained  by  noticing  separately 
the  immediate  and  ultimate  incidence.     (1)  The  immediate  effect  of  the  tax 


FEDERAL,   STATE,   AND   LOCAL  TAXES  715 

will  be  to  discourage  certain  foreign  producers  from  shipping  their  products 
to  the  newly  restricted  market,  and  prices  will  tend  to  rise  because  of  di- 
minished supply.  If  the  product  is  controlled  by  a  foreign  monopoly,  the 
price  may  not  increase;  but  where  the  foreign  production  take  places  under 
competitiv  conditions,  and  in  most  cases  where  the  production  is  monopo- 
lized, the  price  will  be  raised.  The  increase  of  price  may  be  more  or  less 
than  or  equal  to  the  tax  according  to  the  readiness  with  which  foreign  pro- 
ducers find  a  new  market,  but  in  a  large  majority  of  cases  the  burden  of 
the  tax  will  be  shared  by  the  producer  and  consumer,  the  latter,  according 
to  the  majority  of  authorities,  bearing  most  of  the  burden.  That  the  bur- 
den, however,  is  partially  borne  by  the  foreign  producer  accords  not  only 
with  the  best  theory,  but  with  the  great  interest  displayed  by  exporters  every- 
where in  the  tariff  legislation  of  foreign  countries,  and  the  sacrifices  which 
protectionist  governments  are  willing  to  make  in  reciprocity  treaties  for  the 
purpose  of  obtaining  advantageous  terms  for  their  own  producers. 

(2)  Eventually,  however,  the  initial  increase  in  price  may  stimulate  home 
production,  and  this  can  only  take  place  when  the  increase  of  price  is  less 
than  the  duty,  because  if  the  price  rises  by  the  whole  amount  of  the  tax,  the 
foreigner  will  still  possess  his  initial  advantage.  If  the  home  producer  totally 
ousts  the  foreigner,  then  the  consumer  bears  all  the  difference  between  the 
existing  price  and  the  price  that  would  rule  if  no  duty  were  imposed  — 
although,  of  course,  the  treasury  receives  nothing.  If  the  home  producer 
secures  only  a  part  of  the  home  market,  it  is  plain  that,  under  ordinary  cir- 
cumstances, the  foreigner  pays  part  of  the  tax,  i.e.  the  amount  per  unit  of 
product  by  which  the  duty  exceeds  the  increase  of  price;  while,  as  before, 
the  home  consumer  pays,  on  every  unit  consumed,  a  tax  equal  to  the  differ- 
ence between  the  old  and  the  new  prices.  When,  however,  we  attempt  to 
go  further  and  take  account  of  the  indirect  effects  of  protection,  the  problem 
becomes  almost  hopelessly  complex.  Modern  economists,  however,  are 
substantially  agreed  that  the  foreign  producer  bears  a  somewhat  larger  share 
of  the  average  customs  duty  than  the  English  economists  of  the  first  half  of 
the  nineteenth  century  were  willing  to  admit. 

From  the  standpoint  of  revenue,  American  customs  duties 
have  the  great  virtues  of  high  productivity,  convenience  of  pay- 
ment, and  cheapness  of  collection.  Along  with  these  important 
virtues  are  associated  almost  all  the  vices  to  which  indirect  taxes 
are  subject. 

1.  The  most  important  defects  of  our  customs  taxes  are  their 
unreliability  and  uncertainty.  Historically,  they  have  shown  a 
pernicious  variability,  expanding  when  increased  revenue  spelt 
extravagance,  contracting  when  the  country  sorely  needed  larger 
revenue.     In  1791,  for  instance,  the  customs  revenues  exceeded 


716  OUTLINES  OF  ECONOMICS 

the  total  ordinary  expenditures  by  over  41  per  cent,  while  in 
the  very  next  year  they  fell  short  of  the  expenditures  by  58  per 
cent.  Between  1791  and  i860  inclusive,  the  customs  receipts 
actually  exceeded  the  expenditures  in  thirty-four  years ;  varied 
between  50  and  100  per  cent  of  the  expenditures  in  twenty- 
eight  years ;  and  fell  below  50  per  cent  in  eight  years.  In  i860, 
more  than  84  per  cent  of  the  expenditures  were  secured  from 
this  source,  but  in  1863  less  than  10  per  cent,  so  inadequate  is 
the  customs  revenue  in  a  serious  war  when  money  is  most 
needed.  In  1864,  Congress  made  desperate  attempts  to  increase 
the  customs  revenue.  In  the" tariff  act  of  that  year  about  fifteen 
hundred  articles  were  enumerated,  and  the  average  rate  approxi- 
mated 50  per  cent ;  yet  the  receipts  dropped  from  something 
over  one  hundred  and  two  millions  in  1864  to  less  than  eighty- 
five  millions  in  1865,  constituting  only  6.5  per  cent  of  the  total 
expenditures  in  the  latter  year.  During  the  history  of  the 
national  government,  the  customs  revenues  have  varied  with 
the  industrial  condition  of  the  country,  the  prospects  of  peace 
or  war,  the  power  of  the  tariff  lobby,  the  prosperity  and  com- 
mercial policy  of  foreign  nations,  but  almost  never  in  nice  accord- 
ance with  the  financial  needs  of  the  federal  government.  Where 
the  tariff  is  controlled  by  revenue  rather  than  protective  pur- 
poses, it  can  be  made  strikingly  stable  and  responsive  to  the 
control  of  the  treasury.  "  The  English  revenue  from  this 
source  has  kept  very  near  £20,000,000  per  annum  for  the  last 
thirty  years.  In  the  period  1815-1895,  it  has  only  varied  be- 
tween £24,000,000  and  £19,000,000,  notwithstanding  the  exten- 
sive remissions  of  taxation."  ! 

2.  From  the  fiscal  standpoint,  our  tariff  system  is  far  too 
complex  and  cumbersome.  Whether  we  tax  many  imports  or 
few,  the  major  part  of  the  revenue  comes  from  comparatively 
few  imports,  so  that  by  extending  the  list  of  dutiable  articles  we 
merely  add  to  the  cost  of  collection  and  increase  the  interference 
with  commerce,  without  materially  augmenting  the  yield  of  the 
tax.  Before  the  European  War,  Great  Britain  imposed  import 
duties  on  less  than  fifty  articles,  and  nearly  all  of  her  revenue 

1  C.  F.  Bastablc,  Public  Finance,  p.  517  (written  in  1895). 


FEDERAL,   STATE,   AND   LOCAL  TAXES  717 

from  import  taxation  came  from  five  articles :  tobacco,  tea, 
spirits,  wine,  and  sugar.  Compared  with  direct  taxes  the  cost 
of  collecting  our  import  duties  is  not  excessive  (4.42  per  cent 
of  the  receipts  in  191 5),  yet  it  exceeds  the  cost  of  collecting  the 
internal  revenue  duties  (1.50  per  cent  in  1915) ;  and  in  some 
customs  districts  the  expenses  of  collection  actually  exceed  the 
tax  collected. 

"There  is  no  better  illustration  of  a  complex  and  incomprehensible 
revenue  system  than  the  tariff  legislation  of  the  United  States.  It  levies 
import  duties  upon  goods  that  make  up  the  country's  exports  as  well  as  upon 
those  that  constitute  the  normal  imports  of  the  nation's  commerce;  it  taxes 
raw  material  as  well  as  the  manufactured  product,  and  the  manufactured 
product  itself  is  taxed  at  many  stages  in  the  process  of  its  manufacture ;  the 
rate  imposed  is  determined  in  part  by  considerations  of  revenue,  in  part  by 
the  desire  to  grant  'incidental  protection,'  and  in  part  for  the  purpose  of 
prohibiting  the  import  of  selected  articles ;  the  rules  of  rating  are  numerous, 
overlapping  each  other  in  many  cases  and  resulting  in  a  confusion  of  instruc- 
tions that  necessitates  a  board  of  appeal  in  continuous  session ;  the  text  of 
the  law  makes  a  book  of  one  hundred  and  fifty  pages,  while  the  law  and  its 
interpretation  used  by  the  officials  as  a  guide  in  the  performance  of  their 
duty  is  a  volume  of  several  hundred  pages.  A  law  of  this  sort  cannot  be 
comprehended."  1 

Customs  duties  are  either  specific  or  ad  valorem.  Specific 
duties  are  laid  in  proportion  to  weight  or  number,  without  regard 
to  value,  while  ad  valorem  duties  are  levied  in  proportion  to  the 
value  of  the  commodities  imported.  Ad  valorem  duties  are  open 
to  the  objection  that  they  offer  a  greater  temptation  to  fraudu- 
lent valuations,  and  hence  make  more  difficult  the  work  of  the 
customs  officers.  Specific  duties,  on  the  other  hand,  while  they 
can  be  more  easily  administered,  are  open  to  the  serious  objec- 
tion that  they  impose  a  relatively  heavier  burden  upon  less 
valuable  goods  of  any  class.  Owing  to  their  greater  ease  of  col- 
lection, however,  such  specific  duties  now  play  a  larger  part  than 
ever  before  in  our  tariff  system. 

Internal  Revenue  Duties.  —  In  1915  the  internal  revenue 
taxes  yielded  $415,681,024,  or  practically  twice  as  much  as  the 
customs  receipts  for  that  year.     Of  the  total  collections  just 

1 II.  C.  Adams,  Science  of  Finance,  pp.  409,  410. 


718  OUTLINES   OF   ECONOMICS 

one  third  came  from  the  tax  on  spirits ;  a  little  less  than  one 
fifth  (19  per  cent  in  each  case)  from  the  taxes  on  tobacco,  fer- 
mented liquors,  and  incomes,  respectively ;  a  little  less  than  one 
tenth  from  stamp  taxes  on  documents  and  transactions;  and 
the  remainder  from  taxes  on  oleomargarine  and  playing  cards, 
back  taxes,  penalties,  and  the  like.  The  internal  revenues  now 
include  a  number  of  taxes  other  than  the  familiar  excises  on 
articles  of  consumption  which  for  so  many  years  constituted, 
with  customs  duties,  the  fiscal  mainstay  of  the  federal  govern- 
ment ;  but  these  newer  taxes  will  be  left  for  separate  notice 
and  the  remainder  of  this  section  confined  to  the  excises  on  articles 
of  consumption.  Such  excises  are  usually  paid  by  stamps  placed 
upon  the  package  of  sale,  supplemented  by  license  taxes  upon 
dealers,  which  are  also  paid  by  stamps,  as  a  rule,  publicly  ex- 
posed by  the  dealer  in  his  place  of  business. 

Excise  taxes,  like  all  taxes,  have  their  grave  defects.  (1)  Like 
import  duties,  they  must  be  levied  upon  articles  of  wide  con- 
sumption to  be  productive ;  and  as  they  are  in  a  large  degree 
shifted  to  the  consumers,  they  frequently  weigh  more  heavily 
upon  the  poor  than  upon  the  rich!  (2)  This  regressivity  is  in- 
creased by  the  fact  that  the  taxes  are  specific,  not  ad  valorem, 
so  that  the  finer  grades  of  domestic  cigars,  for  instance,  pay  a 
lower  rate  of  taxation  than  the  cheaper  goods.  (3)  In  order  to 
prevent  evasion  of  the  tax,  the  government  is  compelled  not  only 
to  watch,  but  partially  to  direct,  the  process  of  manufacturing 
at  every  step.  Producers  are  required  to  give  bond  for  the 
faithful  observance  of  the  law,  to  register  raw  materials  which 
they  buy,  and  to  keep  records  of  the  stock  on  hand  in  accord- 
ance with  bookkeeping  methods  prescribed  for  them  by  the 
Bureau  of  Internal  Revenue.  Such  interference  with  private  in- 
dustry is  an  unfortunate  but  necessary  part  of  excise  taxation. 
(4)  Large  systematized  businesses  bear  such  interference  with 
less  effort  than  small  concerns,  and  in  consequence  our  internal 
revenue  system  unquestionably  exerts  an  influence  in  the  direc- 
tion of  large-scale  production,  and  possibly  in  the  direction  of 
monopoly.  The  license  taxes  particularly,  which  are  adjusted 
only  in  the  roughest  way  to  the  size  of  the  business,  unquestion- 


FEDERAL,  STATE,  AND   LOCAL  TAXES  719 

ably  weigh  more  heavily  upon  the  small  than  the  large  dealers. 
(5)  Finally,  it  seems  to  be  the  almost  universal  opinion  of  com- 
petent students  that  excise  taxes  exercise  little  influence  upon 
the  consumption  of  articles  whose  use  is  believed  to  be  dele- 
terious. An  increased  tax  is  as  often  followed  by  adulteration 
as  by  an  increase  of  the  price  per  unit. 

The  advantages  of  the  internal  revenue  duties,  however,  far 
outweigh  their  defects.  (1)  Like  the  customs  duties,  they  yield 
an  enormous  revenue;  but  although  they  do  fall  off  somewhat 
in  times  of  industrial  depression,  they  are  in  ordinary  periods 
regular  and  dependable*  while  in  times  of  war  they  respond 
readily  to  increased  rates.  The  increase  of  old  duties  and  the 
imposition  of  new  duties  during  the  Spanish  War,  for  instance, 
raised  the  receipts  from  $170,900,641  in  1898  to  $273,437,162  in 
1899.  Many  of  the  taxes  yield  a  proportional  increase  almost 
as  great  as  the  increase  in  the  rate  of  the  tax,  a  rare  virtue  in 
excise  taxation.  (2)  From  the  administrative  standpoint  they 
are  very  inexpensive  to  collect,  give  rise  to  comparatively  little 
fraud  or  evasion,  and  the  few  industries  which  they  affect  have 
now  become  so  habituated  to  public  inspection  and  control  that 
these  are  occasion  of  little  complaint.  (3)  Finally,  it  is  to  be 
noted  that  although  excise  taxes  are  regressive,  the  burden  of  the 
tax  is  shared  by  producer  and  consumer  —  not  borne  wholly  by 
the  latter  —  and  the  share  borne  by  the  producer  varies  directly 
with  the  element  of  monopoly  or  differential  advantage  in  pro- 
duction. "  Viewed  as  a  whole,  the  internal  revenue  system  is 
the  most  satisfactory  part  of  our  entire  financial  structure,  state 
or  federal.  Its  returns  are  fairly  steady  and  reliable  in  times  of 
depression.  Its  growth  is  automatic.  It  is  imposed  on  articles 
the  demand  fcr  which  is  tolerably  inelastic.  Its  burden  is  not 
perceptibly  felt.  It  is  honestly  and  economically  collected ; 
and  finally,  it  is  abundantly  capable  of  yielding  additional 
revenue,  snould  an  unforeseen  emergency  arise."  1 

Taxes  on  Transactions.  —  In  times  of  urgent  need,  as  in  the 
War  of  1 81 2,  the  Civil  War,  and  the  late  war  with  Spain,  the 
federal  government  has  imposed  taxes  upon  various  sorts  of 

lW.  M.  Daniels,  Public  Finance,  p.  148. 


720  OJTLINES  OF  ECONOMICS 

transactions.  Thus,  the  war  revenue  act  of  1898  imposed  stamp 
taxes  on  bank  checks,  telegrams,  freight  and  express  receipts, 
transfers  of  stocks  and  bonds,  bills  of  exchange,  etc.  In  1899, 
the  year  after  they  were  imposed,  the  stamp  taxes  yielded 
$43,837,819.  Such  taxes  were  again  introduced  in  a  period  of 
declining  customs  receipts  and  increasing  expenditures,  by  the 
so-called  "  war  revenue  act  "  of  1914.  In  1915  this  measure 
yielded  a  revenue  of  a  little  less  than  $38,000,000,  of  which 
$23,500,000  came  from  stamp  taxes  on  documents  and  trans- 
actions and  the  balance  from  special  internal  revenue  duties  of 
the  ordinary  type.  The  peculiar  advantage  of  taxes  on  trans- 
actions is  their  quality  of  immediate  productivity.  As  the 
figures  just  quoted  show,  they  may  be  made  to  yield  largely 
the  very  year  they  are  imposed.  Moreover,  the  government 
may  make  evasion  almost  impossible  by  refusing  to  recognize 
documents  not  properly  stamped  in  its  courts,  or  by  otherwise 
obstructing  the  use  of  unstamped  documents  as  evidence.  An- 
other advantage  is  that  they  cost  almost  nothing  to  collect,  as 
the  taxpayer  buys  the  stamp  himself  and  places  it  upon  the 
document.  On  the  other  hand,  the  general  effect  of  such  taxes 
is  to  impede  business ;  and  they  are  frequently  if  not  usually 
shifted  to  the  weaker  bargainer  in  a  business  transaction.  Cer- 
tainly they  bear  no  logical  relation  to  the  ability  of  the  taxpayer 
to  pay  taxes. 

Income  Taxes.  —  The  recent  adoption  of  effective  income 
taxation  into  this  country  affords  an  interesting  illustration  of 
the  triumph  of  a  sound  economic  idea  over  formidable  obstacles. 
The  legal  barriers  which  had  to  be  surmounted  have  already  been 
mentioned,  but  there  were  other  difficulties  to  overcome  equally 
formidable.  Income  taxes  had  been  on  the  statute  books  of 
American  commonwealths  since  the  seventeenth  century,  and 
had  been  consistently  and  continuously  ineffective.  The  tax 
was  generally  believed  to  be  too  intricate  and  too  inquisitorial 
for  the  American  people,  schooled  by  the  crudities  of  the  general 
property  tax  to  evasion  of  and  contempt  for  tax  law.  Expert 
opinion  had  come  to  hold  that  the  income  tax,  though  "  sound 
in  theory,"  made  too  many  demands  upon  both  the  taxpayer 


FEDERAL,  STATE,   AND   LOCAL  TAXES  721 

and  the  tax  administrator  to  thrive  in  American  soil.  Yet  in 
the  last  five  years  income  taxes  of  the  European  type  have  been 
put  into  successful  operation  by  both  state  and  federal  govern- 
ments and  give  every  promise  of  assuming,  in  the  future,  a  place 
of  major  importance  in  the  American  fir-cal  system. 

The  mistake  of  the  experts  arose  rather  from  an  underestimate 
of  the  strength  of  the  income  tax  than  from  an  underestimate 
of  its  difficulties.     The  alleged  weaknesses  of  the  income  tax 
were  not  imaginary.     Experience  has  shown  that  it  is  a  complex 
and  difficult  tax  to  formulate  and  administer.     Just  what  items 
of  gross  income  should  be  included  and  what  losses,  expenses, 
and  other  deductions  allowed,  are  questions  which  bristle  with 
difficulties.     Some  forms  of  income  are  not  expressed  in  money 
and  usually  escape  taxation ;  on  the  other  hand,  it  is  almost  im- 
possible to  avoid  double  taxation,  particularly  in  dealing  with 
interest  and  dividends.     The   tax  has  also  the  difficulty  of 
being  a  class  tax :   the  federal  income  tax  touches  directly  less 
than  one  per  cent  and  the  Wisconsin  income  tax  less  than  three 
per  cent  of  the  respective  populations  affected.    The  tax  is 
predominantly  a  city  tax  and  farmers  generally  escape,  owing 
to  the  facts  that  they  usually  do  not  keep  books  and  that  much 
of  their  income  does  not  find  expression  in  terms  of  money ; 
although  it  must  be  admitted  that  relatively  few  farmers  receive 
incomes  above  the  exemption  limit.     Finally,  the  mixture  of 
"  withholding  at  source  "  and  direct  collection,  in  the  federal 
tax,   imposes  large  and   unjust   expenses  of  collection   upon 
private  taxpayers,  complicates  the  administration  of  the  tax, 
and  in  some  cases  leaves  the  taxpayer  to  become  the  sole  judge 
of  the  taxability  of  certain  items  of  income  and  of  the  deduc- 
tibility of  certain  losses  and  expenses.1 

Despite  all  these  difficulties,  however,  the  income  tax  has 
succeeded.  It  is  reasonably  productive  and  will  become  more 
productive  as  time  passes:  the  federal  income  tax  in  191 5 
yielded  a  revenue  of  over  $80,000,000,  and  in  1916  it  produced 

1  A  criticism  of  the  federal  income  tax  by  a  disinterested  and  competent  com- 
mittee of  the  National  Tax  Association  will  be  found  in  the  Proceedings  of  that  asso- 
ciation, vol.  ix. 


722 


OUTLINES   OF  ECONOMICS 


over  $100,000,000.  It  is  elastic,  and  can  be  made  more  produc- 
tive by  simple  increase  of  rates.  Above  all  else,  it  realizes  with 
reasonable  success  "  taxation  according  to  ability."  Property 
taxes  pay  little  attention  to  the  ability  of  the  owner  of  the 
property.  They  fall  upon  property  as  such  whether  it  is  free  or 
encumbered  by  debt ;  they  must  be  paid  by  the  unsuccessful  as 
well  as  the  successful ;  in  lean  years  as  well  as  fat  years.  The 
income  tax,  on  the  other  hand,  does  not  affect  the  very  poor 
at  all ;  it  spares  the  unsuccessful  business,  the  new  business 
in  its  developmental  stage,  and  the  old  established  enterprise 
in  times  of  business  depression.  Its  appeal  is  thus  not  only  to 
the  humanitarian  sentiment  of  the  age,  but  to  the  common 
sense  of  the  business  man.  Except  when  collected  at  source 
(when  it  acts  in  small  part  like  an  excise)  it  is  subject  to  little 
or  no  shifting.  And,  unlike  the  property  tax,  it  grows  stronger 
with  age  and  continued  use.  The  countries  which  have  tried 
the  income  tax  keep  it ;  and  in  the  last  quarter  of  the  century 
practically  every  large  country  in  the  world  which  did  not 
already  have  the  income  tax  has  introduced  it. 

The  mistake  of  the  critics  in  condemning  the  income  tax  for 
American  use  was  due  very  largely  to  a  misinterpretation  of  the 
failure  of  the  personal  property  tax.  That  tax  is  largely  evaded. 
The  critics  inferred  from  this  that  American  taxpayers  are  liars 
and  would  similarly  evade  an  income  tax.  Experience  with  the 
income  tax  has  shown,  however,  that  the  average  American  tax- 
payer is  honest  and  will  make  an  honest  declaration  if  the  tax 
be  equitable  and  tax  officials  at  the  same  time  firm,  competent, 
and  considerate.  The  personal  property  tax  in  this  country  has 
failed,  not  because  the  taxpayer  is  dishonest,  but  because  the 
tax  is  at  times  barbarously  severe  in  burden,  strikingly  un- 
equal in  operation,  and  administered  by  officials  who  are  fre- 
quently incompetent  and  out  of  sympathy  with  the  tax  itself. 
Moreover,  the  income  tax  is  no  more  complicated  than  any 
other  direct  tax  involving  valuation  and  assessment.  It  ap- 
pears to  be  more  complicated  than  the  property  tax  merely 
because  in  drafting  income  tax  laws  it  is  customary  to  anticipate 
all  problems  of  detail  and  define   the  proper   answer   in  the 


FEDERAL,   STATE,  AND  LOCAL  TAXES  723 

statute  itself;  whereas,  in  property  tax  laws  almost  all  the  diffi- 
cult questions  are  avoided  by  laying  the  tax  on  the  "  fair  cash  " 
or  "  market  value  "  and  leaving  the  meaning  of  this  term  to 
be  decided  by  the  judgment  of  the  assessor.  In  the  average 
case,  it  is  easier  to  determine  a  man's  income  with  reasonable 
accuracy  than  it  is  to  determine  with  the  same  degree  of  accu- 
racy what  his  property  is  worth. 

Absentee  ownership  increases  with  industrial  development, 
and  much  income  is  now  derived  from  particular  jurisdictions 
by  persons  who  reside  elsewhere.  This  leads  in  practice  to 
double  taxation,  as  both  the  jurisdiction  in  which  the  recipient 
lives  and  that  in  which  the  income  originates  are  likely  to  im- 
pose the  tax.  Such  double  taxation  is  reduced  as  the  jurisdic- 
tion is  enlarged  to  which  the  income  tax  applies ;  and  for  this 
reason  many  authorities  advocate  the  exclusive  employment  of 
the  income  tax  by  the  federal  government.  If  the  income  tax 
cannot  be  employed  by  both  state  and  federal  governments, 
this  conclusion  is  warranted.  But  we  see  no  reason  why  the 
states  should  renounce  the  income  tax  and  use  substitutes  which 
are  manifestly  inferior,  merely  because  the  federal  government 
is  employing  the  same  tax.  Nearly  all  taxes  must  be  paid  out 
of  income.  The  specific  tax  employed  is  merely  a  device  for 
distributing  the  tax.  Why,  then,  should  the  state  employ  a  poor 
method  of  distribution,  such  as  that  embodied  in  the  personal 
property  tax,  when  it  might  employ  a  tax  which  with  substan- 
tial accuracy  lays  the  burden  in  accordance  with  ability  to  pay? 
As  a  matter  of  fact,  the  federal  income  tax  is  likely  to  encourage 
the  adoption  of  state  income  taxes,  because  the  federal  tax  fa- 
miliarizes the  people  with  income  tax  procedure,  and  with 
simple  modifications  a  report  prepared  for  the  federal  govern- 
ment can  be  used  for  the  state  government.  We  should  have, 
not  hostility  between  state  and  federal  administrations,  but 
joint  and  cooperative  use  of  many  forms  of  taxation. 

Inheritance  Taxes.  —  In  1893,  when  the  first  edition  of  this 
work  was  written,  the  inheritance  tax  was  used  in  only  five 
states,  and  so  strong  were  the  objections  to  its  wide  adoption 
that  the  author  felt  called  upon  to  point  out  that  unregulated 


724  OUTLINES  OF   ECONOMICS 

collateral  inheritance  was  an  unjustifiable  survival  of  the  clan 
system  that  was  being  carried  to  ridiculous  lengths  at  that 
time.  Since  that  time,  however,  inheritance  taxation  has  spread 
rapidly,  being  employed  in  about  forty  states  in  191 5,  and  with 
the  spread  of  the  tax  has  come  a  most  significant  development 
of  progressive  rating  and  taxation  of  direct  as  well  as  collateral 
heirs.  Today  one  never  hears  of  the  "  inherent  right "  of 
decedents  to  control  absolutely  the  disposition  of  their  property 
in  perpetuity,  and  die  right  of  the  legislature  to  regulate  in- 
heritance in  behalf  of  the  general  social  welfare  is  hardly  dis- 
puted. Mr.  Andrew  Carnegie,  for  instance,  advocates  a  rate  of 
50  per  cent  upon  the  estates  of  millionaires. 

At  present  the  inheritance  tax  produces  substantial  revenues 
in  only  a  few  states;  in  1913,  the  latest  year  for  which  complete 
statistics  are  available,  35  states  showed  collections  aggregat- 
ing $26,470,964,  of  which  the  six  states  of  New  York,  Pennsyl- 
vania, Massachusetts,  California,  Illinois  and  Connecticut  re- 
ceived 78  per  cent.  The  important  fact  is  that  the  initial  in- 
ertia and  opposition  have  been  overcome  and  the  ground  cleared 
for  the  really  efficient  use  of  this  tax  as  a  means  of  reducing 
large  fortunes  and  increasing  public  revenues.  The  new  type 
of  the  inheritance  tax  is  well  illustrated  by  the  Wisconsin  law, 
which  applies  to  direct  as  well  as  collateral  heirs,  and  which 
graduates  the  rates  according  to  relationship  and  the  amount 
of  the  individual  share,  and  not  by  the  size  of  the  estate.  The 
highest  rate  in  the  Wisconsin  tax,  applying  to  shares  in  excess  of 
$500,000  given  to  distant  relatives  and  strangers,  is  15  per  cent. 

Great  as  our  progress  has  been  in  this  respect,  our  legislation 
still  falls  short  of  the  demands  of  common  sense.  Why  should 
collateral  inheritance,  apart  from  a  will,  be  permitted  at  all  ex- 
cept among  near  relatives?  Why  should  third  cousins  inherit 
from  one  another  unless  money  is  left  by  will  ?  Are  third  cousins 
nearer  to  one  than  the  town  or  city  in  which  one  has  lived  and 
where  one  has  been  able  to  acquire  a  fortune?  The  extent  to 
which  intestate  collateral  inheritance  is  carried  is  a  survival  of 
the  sentiment  of  the  time  when  people  lived  in  clans,  and  is 
illogical  in  our  day.     Right  and  duty  should  be  coordinated. 


FEDERAL,   STATE,   AND   LOCAL  TAXES  725 

Ought  I  to  be  compelled  by  law  to  support  an  uncle  who  is  un- 
able by  incapacity  to  earn  a  livelihood  ?  Then  I  should  inherit 
from  him ;  otherwise  it  does  not  seem  clear  that  I  should  unless 
he  leaves  me  property  by  will.  So  far  as  practicable  the  circle 
of  legal  duties  ought,  however,  to  be  extended  so  as  to  include 
the  circle  of  vital  relationship.  The  property  should  go  to  the 
State  in  the  absence  of  near  relatives  when  no  will  is  made. 
The  clan  is  dead  and  forgotten ;  ordinarily  there  is  neither  ac- 
quaintance nor  recognizable  obligation  between  second  cousin :s, 
not  to  mention  twenty-second.  Inheritances  thus  bestowed  are 
pure  gifts,  wanton  disturbances  of  existing  abilities  to  use 
property.  The  modem  clan  is  society,  and  to  it  belong  all  claims 
to  inheritance  falling  outside  the  circle  of  vital  relations.  The  en- 
lightened English  jurist,  Jeremy  Bentham,  wished  to  restrict 
inheritance  and  extend  escheat,  and  thus  abolish  taxation 
altogether,  but  this  is  going  too  far. 

At  present  the  inheritance  tax  in  this  country  is  too  light  to 
satisfy  the  requirements  of  sound  inheritance  taxation.  The 
average  inheritance  tax,  even  in  the  case  of  large  estates  divided 
into  large  shares,  is  less  than  3  per  cent :  and  it  is  very  difficult 
for  one  state  to  increase  the  rates  if  neighboring  states  do  not 
do  the  same.  Moreover,  state  inheritance  taxes  give  rise  to 
multiple  taxation.  Land  devolves  at  situs,  and  its  devolution 
is  taxed  at  situs.  But  our  most  valuable  land  is  rapidly  pass- 
ing into  corporate  ownership,  and  corporations  do  not  die. 
The  corporate  securities  which  represent  the  land  are,  under 
the  inheritance  tax,  normally  taxed  at  the  domicile  of  the  de- 
cedent. This  is  likely  to  be  in  another  state.  Hence  many 
states,  the  western  states  in  particular,  try  to  tax  not  only  the 
transfer  of  securities  owned  by  resident  decedents,  but  also 
the  transfer  of  securities  "  representing "  property  located 
within  their  borders.  This  is  selfish  and  inconsistent.  Both 
principles  cannot  find  an  equitable  and  logical  place  in  the  same 
tax  law.  But  it  is  expensive  and  difficult  to  administer  an 
inheritance  tax  on  the  "  situs  principle  " ;  and  when  a  holding 
company  or  series  of  holding  companies  intervenes  between  the 
security  and  the  tangible  property  which  that  security  repre- 


726  OUTLINES   OF  ELuNOMICS 

sents,  it  is  almost  impossible.  Other  states,  again,  tax  the  trans- 
fer of  securities  held  in  trust  companies  located  therein ;  while 
still  others  pile  inconsistency  upon  inconsistency  by  giving 
bonds  issued  by  their  municipalities  a  situs  within  their  own 
borders,  in  order  that  the  transfer  of  such  bonds  may  be  taxed 
upon  the  death  of  their  nonresident  owners.  The  writer  has 
known  one  block  of  securities  to  be  taxed  in  three  different, 
states,  and  it  was  possibly  taxed  later  in  a  fourth  state. 

Under  these  circumstances,  many  people  advocate  as  a 
remedy  the  collection  of  the  tax  by  the  federal  government, 
with  a  redistribution  of  a  part  of  the  proceeds  to  the  state 
governments.  The  principal  argument  for  this  change  is  the 
assertion  that  the  federal  government  can,  while  the  state 
governments  cannot,  realize  the  full  possibilities  of  inheritance 
taxation,  so  that  the  federal  government  can  give  the  states 
more  than  they  are  now  receiving  from  this  source  and  still 
retain  a  handsome  revenue  for  federal  uses.  This  project  is, 
however,  deeply  resented  by  state  tax  officials,  who  point  out 
that  the  probate  courts,  the  natural  machinery  for  administer- 
ing inheritance  taxes,  are  in  the  hands  of  the  state  governments, 
and  that  there  was  considerable  evasion  of  the  inheritance  tax 
adopted  by  the  federal  government  during  the  Spanish  War. 

We  believe  that  the  solution  of  the  problem  lies  in  cooperative 
and  joint  use  by  federal  and  state  governments.  Neither  divi- 
sion of  government  can  be  prevented  from  using  this  tax,  and 
fiscal  necessity  will  almost  certainly  force  the  federal  government 
to  make  use  of  it  in  the  near  future.  That  being  the  case, 
common  sense  points  to  the  desirability  of  administrative  co- 
operation, and  the  elimination  by  the  larger  sovereignty,  if  pos- 
sible, of  double  taxation  arising  from  conflicts  of  jurisdiction. 

State  and  Local  Taxation 

General  Property  Tax.  —  The  key  to  the  revenue  system  of 
our  state  and  local  governments,  and  by  far  the  most  important 
tax  collected  in  the  United  States,  is  the  general  property  tax, 
which  supplied,  in  1902,  82  per  cent  of  the  tax  receipts  of  the 


FEDERAL,   STATE,   AND   LOCAL   TAXES  727 

state  and  local  governments  and  51  per  cent  of  all  taxes  col- 
lected in  the  country,  (1)  national,  state,  and  local.  The  most 
important  characteristic  of  this  tax  is  suggested  by  the  word 
"  general,"  —  the  tax  is  levied  in  principle  upon  nearly  all  property, 
real  and  personal,  in  the  hands  of  the  people. 

Though  the  administration  of  the  property  tax  differs  in  many 
details  among  the  states,  it  is  the  usual  custom  for  assessors  in 
each  community  to  prepare  complete  statements  of  all  kinds  of 
taxable  property  owned  by  the  people  of  the  community.  In 
some  states  the  assessors  receive  from  all  residents  sworn  "  lists  " 
of  property  owned  and  subject  to  tax.  By  the  terms  of  the  law 
the  property  is  supposed  to  be  rated  at  its  true  full  value, 
though,  by  the  acknowledged  practice  of  assessors  and  courts 
of  review,  the  real  rates  vary  widely  from  state  to  state,  from 
community  to  community,  and  from  individual  to  individual. 
On  the  basis  of  the  property  valuations  thus  made  the  state 
and  local  governments  levy  direct  taxes  at  a  rate  fixed  from 
year  to  year  according  to  fiscal  needs.  The  tax  is  then  collected 
by  local  officers,  and  of  the  whole  amount  the  portion  levied  by 
the  county  and  state  is  passed  on  to  the  designated  officers 
after  each  minor  political  division  has  set  aside  its  share. 

As  yet  few  economists  who  have  written  upon  the  subject,  and 
few  state  officers  who  have  had  to  do  with  the  administration  of 
the  tax,  have  ever  been  able  to  speak  of  it  except  in  terms  of  the 
severest  condemnation.  Naturally,  then,  there  is  now  a  strong 
tendency  to  work  away  from  this  form  of  taxation.  Some  of 
the  many  serious  faults  which  the  general  property  tax  has 
everywhere  shown  call  for  comment  and  explanation. 

1.  Unjust  Apportionment. — The  first  of  the  defects  of  the 
tax  appears  in  the  apportionment  of  the  state's  share  of  the  tax. 
Each  community  has  a  narrow,  selfish  interest  in  reducing  its 
assessment  so  that  it  may  escape  its  just  share  of  the  tax.  The 
same  mean  struggle  is  especially  frequent  between  city  and 
country  districts.  To  correct  the  evil,  boards  of  equalization 
are  usually  appointed,  but  experience  has  shown  that  such  boards 
usually  do  their  work  in  a  most  perfunctory  way.  Although 
earnest  study  of  assessments  may  and  sometimes  does  secure  a 


728  OUTLINES  OF  ECONOMICS 

substantially  just  apportionment  between  county  and  county, 
this  equalization  does  not  correct  the  glaring  inequalities  within 
particular  counties,  and  even  within  single  assessment  districts. 

2.  Inequality  as  between  Realty  and  Personalty.  —  In  the 
second  place,  the  general  property  tax  has  proved  grossly  in- 
equitable in  laying  an  undue  proportion  of  its  burden  upon  real 
property,  allowing  various  forms  of  personal  property  to  escape 
with  a  slight  tax  or  with  no  tax  at  all.  A  secondary  result  of 
this  inequality  is  that  the  rural  districts  bear  a  disproportionate 
burden,  since  the  greater  part  of  the  tax-escaping  personalty  is 
owned  by  the  wealthy  citizens  of  our  cities. 

3.  Undervaluation  of  Large  Properties. —  Very  similar  to  the 
preceding  evils  is  the  further  injustice  wrought  by  the  tax 
through  the  disproportionate  assessment  of  large  and  small 
properties.  Thus,  an  investigation  in  Virginia  covering  over 
sixteen  thousand  pieces  of  property,  showed  that  while  th( 
average  ratio  of  assessed  to  true  value  was  33  per  cent,  parcel? 
worth  less  than  $500  were  assessed  at  47  per  cent  of  full  value, 
and  parcels  worth  more  than  $10,000  at  only  28  per  cent  oi 
full  value.1 

4.  Temptation  to  Dishonesty.  —  It  follows  from  the  evil  J 
already  described  that  the  general  property  tax  leads  to  a  shock- 
ing amount  of  dishonesty,  perjury,  bribery,  and  other  forms  of 
corruption.  Indeed,  as  one  writer  has  expressed  it,  "  The 
general  property  tax  has  gone  far  toward  making  perjury  re- 
spectable and  even  virtuous." 

5.  Fundamental  Theoretical  Defects. — But  the  most  funda- 
mental defect  of  the  general  property  tax  is  found  in  the  fact  that 
it  is  an  incongruous  mixture  of  real  and  personal  taxes.  Real 
estate,  in  a  great  majority  of  states,  is  taxed  at  its  situs,  irrespec- 
tive of  ownership  or  the  tax-paying  ability  of  the  owner.  The 
personal  obligation  of  the  owner  to  support  the  government 
under  which  he  immediately  lives  is  met  practically  everywhere 
by  that  part  of  the  tax  which  falls  upon  personal  property,  per- 
sonal property  paying  at  the  domicile  of  the  owner. 

This  distinction  between  real  and  personal  property  is  artificial, 

1  Report  of  the  Joint  Committee  on  Tax  Revision  (Virginia),  1914,  p.  101. 


FEDERAL,   STATE,   AND  LOCAL  TAXES  729 

inequitable,  and  illogically  applied.  Personalty,  as  a  measure  of 
ability  to  pay  taxes,  ought  to  be  accurately  computed  by  offset- 
ting liabilities  against  assets,  so  that  the  taxpayer  would  pay 
only  upon  net  assets.  Yet  no  state,  with  the  possible  exception 
of  New  Jersey,  grants  full  and  complete  exemption  of  debts; 
only  three  states  permit  a  subtraction  of  debts  from  all  per- 
sonalty ;  the  rest  either  refusing  any  abatement  for  debts  what- 
soever or  limiting  the  abatement  to  subtraction  of  debts  from 
money,  or  money  and  credits,  or  other  restricted  classes  of  per- 
sonalty. Moreover,  nearly  all  the  states  manipulate  their  defini- 
tions of  real  property  in  the  most  discreditable  manner,  causing 
many  kinds  of  double  taxation.  To  take  a  single  illustration : 
most  states  tax  the  stock  of  foreign  corporations  held  by  resi- 
dent citizens,  whether  the  corporation  pays  full  taxes  at  its  situs 
or  not.  Many  of  these  states  tax  their  own  or  domestic  corpora- 
tions at  full  value,  thus  indorsing  the  theory  that  a  corporation 
should  be  taxed  as  a  business  unit  where  the  business  is  carried 
on.  Nevertheless,  they  attempt  to  tax  the  stock  of  foreign  cor- 
porations when  the  stock  is  the  only  thing  they  can  reach. 
Some  states,  though  not  a  majority,  actually  tax  both  the  shares 
of  stock  and  the  business  of  domestic  corporations,  and  then 
wonder  that  the  stockholders  attempt  to  evade  the  inequitable 
obligations  imposed  upon  them  by  law. 

Reform  of  the  Property  Tax.  —  This  brief  outline  of  the  evils 
connected  with  the  general  property  tax  furnishes  us  with  the 
key  to  reform.  By  far  the  greatest  reform  that  could  possibly 
be  accomplished  would  result  from  placing  the  work  of  assess- 
ment on  a  scientific  basis,  by  appointing  expert  assessors  under 
civil  service  protection,  who  would  give  their  whole  time  to  the 
business  and  hold  their  places  during  good  behavior.  In  1902 
practically  three  fourths  of  the  revenues  collected  under  the 
general  property  tax  came  from  the  tax  on  real  property.  We 
shall  undoubtedly  keep  the  real  estate  tax.  Scarcely  any  one 
advocates  its  abandonment  or  believes  that  it  will  be  possible 
to  get  along  without  it ;  and  with  trained  assessors  it  would  be 
possible  to  make  a  substantially  fair  assessment  of  real  property. 
Yet  even  the  assessment  of  real  estate  is  in  most  places  today 


730  OUTLINES  OF  ECONOMICS 

markedly  unequal.  We  spend  a  great  deal  of  time  thinking  out 
ambitious  fiscal  reforms  that  will  remedy  the  present  system  by 
revolutionizing  it,  overlooking  the  fact  that  the  remedy  for  the 
deepest  and  widest  evil  lies  within  our  reach,  neglected  and  un- 
availing, not  because  we  are  ignorant  of  its  potency,  but  because 
we  lack  the  will  resolutely  to  apply  it. 

At  the  same  time,  no  assessor,  however  expert  and  well  paid, 
can  ever  be  expected  to  assess  all  kinds  of  personal  property  with 
even  approximate  accuracy.  To  persist  in  the  attempt  to  assess 
all  the  property  of  every  person  is  simply  to  debase  public 
morality  and  convince  assessors  that  nothing  short  of  divine  wis- 
dom will  enable  them  to  satisfy  the  requirements  of  the  law. 
In  short,  the  more  intangible  forms  of  personal  property,  if  not 
all  personal  property,  must  be  exempted  from  taxation,  and  the 
loss  be  made  up  by  the  introduction  of  simpler  and  more  work- 
able taxes.  Probably  the  best  substitute  is  an  income  tax,  or 
what  has  been  called  a  "  presumptive  ability  tax  "  based  upon 
house  rent,  rental  value  of  business  premises,  salary,  or  all  of 
them.  In  individual  cases  such  a  tax  would  violate  the  rules  of 
exact  justice,  but  with  suitable  exemptions  and  proper  adjust- 
ments it  might  be  roughly  equitable. 

The  personal  property  tax  on  business  and  commercial  con- 
cerns, with  its  impossible  requirements  of  stock  valuations, 
taxation  of  book  accounts,  bills  receivable,  and  credits  generally, 
should  be  replaced  by  a  tax  on  gross  or  net  income,  or  by  some 
simple  form  of  license  taxation.  We  should  then  have,  in  place 
of  the  general  property  tax,  a  tax  on  real  estate,  a  business  tax, 
and  a  personal  tax  measured  by  net  income  or  evidences  of  in- 
come. Although  the  real  estate  tax  would  in  appearance  take 
no  cognizance  of  mortgages  or  debts  secured  by  the  property 
and  no  account  on  the  surface  of  the  ability  of  the  owner,  it 
would  not  in  reality  wholly  violate  the  canon  of  taxation  accord- 
ing to  ability.  The  man  buying  land  on  contract  or  subject 
to  a  mortgage,  would  take  into  account  the  fact  that  he  would 
be  called  upon  to  pay  taxes  upon  the  whole  value  of  the  property, 
irrespective  of  debt  or  incumbrance,  and  the  price  would  be 
adjusted  accordingly.     Or,  if  he  mortgaged  his  land  after  he 


FEDERAL,   STATE,  AND  LOCAL  TAXES  731 

had  acquired  ownership,  he  would  be  indemnified  in  most  cases 
for  paying  all  the  taxes,  by  receiving  a  lower  rate  of  interest  on 
his  mortgage  than  he  would  be  enabled  to  secure  if  the  creditor 
were  liable  for  taxes  upon  that  part  of  the  property  covered  by 
the  mortgage.  Real  taxes,  which  take  no  cognizance  of  the 
financial  status  of  the  owner,  are  not  inequitable  when  they  are 
consistently  applied  and  supplemented  by  a  separate  system  of 
personal  taxation. 

All  these  taxes  destined  to  take  the  place  of  the  general 
property  tax  may  possibly,  in  the  future,  be  assigned  to  the  local 
governments,  although  administered  in  some  cases  by  the 
central  government.  If  necessary  to  provide  enough  revenue 
for  the  state,  however,  a  small  state  tax  could  equitably  be 
levied  upon  real  estate,  as  the  equalization  of  real  estate  assess- 
ments among  the  larger  governmental  divisions,  such  as  coun- 
ties, is  a  comparatively  easy  matter.  Whether  the  state  will  be 
able  to  get  along  without  taxes  upon  real  estate,  depends  prin- 
cipally upon  the  productivity  of  certain  corporation  taxes,  the 
proceeds  of  which  belong  logically  to  the  state  rather  than  to 
the  local  governments.  This  absorption  of  corporation  taxes 
by  the  state  is  already  well  under  way  in  the  New  England  and 
Middle  Atlantic  states.  In  1915,  for  instance,  New  York,  New 
Jersey,  and  Pennsylvania  together  raised  $70,078,685  from 
special  property  and  business  taxes  (practically  corporation 
taxes),  but  only  $18,743,626  from  the  general  property  tax. 
In  that  year  Delaware  made  no  use  of  the  general  property  tax 
at  all  for  state  purposes.  However,  the  breakdown  of  the  general 
property  tax  has  by  no  means  been  accomplished  yet.  In  all 
the  states  and  territories  in  19 15,  51  per  cent  of  the  total  tax 
receipts  came  from  the  general  property  tax,  23  per  cent  from 
special  property  taxes,  22  per  cent  from  business  taxes,  less 
than  1  per  cent  from  poll  taxes,  and  something  over  4  per  cent 
from  miscellaneous  licenses.  These  proportions  are  based  upon 
state  receipts.  If  local  revenues  were  included,  the  general 
property  tax  would  appear  much  more  important. 

Corporation  Taxes.  —  The  exact  way  in  which  any  corpora- 
tion should  be  taxed  depends  upon  a  great  variety  of  considera- 


732  OUTLINES  OF  ECONOMICS 

tions,  which  vary  from  place  to  place  and  from  time  to  time. 
In  general,  however,  the  following  elements  may  be  detected  in 
the  more  progressive  systems  of  corporation  taxation:  (i)  The 
incorporation  fee,  justified  by  the  clerical  expenses  of  registering 
corporations  and  the  value  of  the  privileges  granted  to  every 
corporation,  the  most  important  of  which  is  that  of  limited 
liability.  This  charge  should  be  imposed  on  all  joint-stock 
companies,  should  vary  with  the  amount  of  bonds  as  well  as 
the  amount  of  stock  authorized,  and  should  be  small,  unless 
the  state  desires  narrowly  to  restrict  the  incorporation  of  com- 
mercial enterprises.  (2)  The  franchise  tax  proper,  to  cover 
especially  valuable  privileges,  such  as  the  right  to  use  the  public 
streets  or  highways,  granted  to  most  public  utility  companies. 
This  is  essentially  a  contractual  payment,  a  lease  or  royalty 
rather  than  a  tax.  It  should  be  fixed  in  advance  for  a  definite 
period  at  as  high  a  figure  or  rate  as  is  just,  and,  when  fixed, 
should  not,  in  justice  to  the  corporation,  be  tampered  with  by 
the  state.1  In  states  having  public  service  commissions  power- 
ful enough  to  control  rates  effectively,  this  tax  or  payment  may, 
and  perhaps  should,  be  relinquished  in  favor  of  correspondingly 
lower  rates  and  better  service.  (3)  The  general  property  tax 
or  some  equivalent,  designed  to  impose  upon  the  corporation  a 
burden  equivalent  to  that  borne  by  the  average  taxpayer  of  the 
district.  Inasmuch  as  good  will,  business  organization,  and 
similar  intangible  assets  are  property,  property  taxes  imposed 
under  this  head  should  cover  not  only  tangible  but  intangible 
values  as  well,  including  the  franchise,  when  this  does  not  revert 
to  the  state.  Corporations  which  have  received  valuable  fran- 
chises from  the  state  may  properly  be  called  upon  to  pay  for 
the  privilege  (under  2)  as  well  as  upon  the  privilege  (under  3). 

This  differentiation  of  what  may  be  called  the  bases  of  cor- 
poration taxation  should  not  be  misunderstood.  Many  states 
merge  two  or  even  three  of  these  charges  in  a  single  tax,  and 

1  However,  where  a  long  or  perpetual  franchise  is  given,  provision  should  be  made 
for  the  readjustment  of  the  rental  by  arbitration  or  in  some  other  equitable  way. 
An  illustration  is  found  in  the  terms  of  the  franchise  under  which  the  Pennsylvania 
railroad  built  a  tunnel  under  the  North  River  and  erected  its  new  station  in  New 
York  City. 


FEDERAL,   STATE,   AND   LOCAL  TAXES  733 

other  states  exempt  savings  banks,  insurance  companies,  and 
other  kinds  of  corporations  from  one  or  all  of  these  obligations 
in  order  to  encourage  thrift  or  foster  the  industry  exempted. 
Such  exemptions  are  often  justifiable  and  socially  helpful.  But 
unless  these  separate  elements  are  kept  plainly  in  mind,  injus- 
tice is  almost  sure  to  follow.  To  impose,  or  try  to  impose, 
charge  (2)  upon  all  corporations,  on  the  theory  that  all  of  them 
have  received  exceedingly  valuable  privileges,  is  to  confuse 
general  with  special  corporation  privileges,  and  to  pave  the  way 
for  "  corporation-baiting."  Finally,  although  it  is  not  neces- 
sary, we  believe  real  progress  will  be  hastened  by  observing 
these  distinctions  in  practice  as  well  as  in  theoretical  analysis. 

Business  and  License  Taxes.  —  In  most  Southern  states 
there  is  an  extensive  system  of  business  licenses,  which  supple- 
ment and  partly  replace  the  general  property  tax.  The  sig- 
nificance and  importance  of  these  business  licenses  have  not 
hitherto  been  sufficiently  appreciated.  They  are  levied  in 
theory  under  the  regulative  power  of  the  government  rather 
than  the  taxing  power ;  but  they  have  by  extension  and  multi- 
plication become  taxes  for  the  most  part,  as  distinguished  from 
sumptuary  charges  or  payments  for  small  privileges. 

The  license  system  of  the  South  is  characterized  by  many 
defects.  Here  and  there  traces  of  class  feeling  are  discerned, 
as  in  the  prohibitive  license  taxes  levied  upon  peddlers;  and 
the  rates  employed  are  often  illogical,  inconsistent,  and  in- 
equitable to  the  point  of  absurdity.  In  a  few  cases  also,  these 
taxes  are  high  enough  to  bar  certain  occupations  to  the  man 
with  small  capital.  But  on  the  whole  they  are  among  the  best 
taxes  employed  by  American  commonwealths.  They  are  easily 
and  cheaply  collected,  very  productive,  cause  little  or  no  com- 
plaint, are  not  excessive  as  a  rule,  and  exercise  little  or  no  in- 
fluence upon  prices.  And  in  so  far  as  they  discourage  the 
excessive  multiplication  of  small  retail  shops  they  perform  the 
useful  service  of  preventing  almost  inevitable  loss  and  bank- 
ruptcy. 

The  great  significance  of  the  business  license  is  its  expression 
of  the  truth  that  the  general  property  tax  in  its  crude  form  is 


734  OUTLINES  OF   ECONOMICS 

unsuited  to  the  taxation  of  business.  Under  the  property  tax, 
business  in  general  is  taxed  upon  its  tangible  assets,  i.e.  fixed 
plant  and  stock.  One  has  only  to  think  of  the  varying  relation- 
ship to  taxable  capacity  of  the  plant  and  stock  of  a  manufac- 
turer, a  grocer,  a  druggist,  and  a  stock  broker,  to  realize  the 
grave  injustice  of  this  method  of  taxation.  In  countries  of  con- 
tinental Europe,  and  in  parts  of  Canada,  as  in  the  southern  part 
of  the  United  States,  a  wide  and  generally  satisfactory  use  is 
made  of  the  business  tax.  Eventually  we  shall  probably  come 
to  the  same  thing  in  all  parts  of  this  country.  But  the  tax 
should  be  adjusted  to  earnings  or  profits  in  a  more  effective 
way  than  is  now  done  in  the  South. 

Poll  Taxes.  —  The  poll  tax  is  the  oldest  tax  we  have  in  this 
country,  and  throughout  the  greater  part  of  the  colonial  period 
yielded  more  than  any  other  source  of  revenue.  It  aroused  bitter 
opposition  in  many  commonwealths  and  was  prohibited  by  the 
liberal  constitution  of  Maryland  at  the  beginning  of  the  Revolu- 
tionary War;  but  it  persisted  in  many  of  the  states,  and  still 
remains  the  most  important  source  of  revenue,  after  the  property 
tax,  in  a  few  of  the  Southern  states.  The  tax  still  stands  on  the 
statute  books  of  about  one  half  of  the  states,  and  is  nominally 
employed  as  a  highway  or  local  tax  in  a  still  larger  number  of 
commonwealths ;  but  in  many  places  little  or  no  effort  is  made 
to  enforce  it.  In  Wisconsin,  for  instance,  no  attempt  is  made 
to  collect  the  poll  tax  in  more  than  half  of  the  local  taxing  dis- 
tricts. The  poll  tax  is  not  only  difficult  to  collect,  but  is  regres- 
sive and,  when  its  payment  is  required  as  a  prerequisite  to  the 
exercise  of  the  suffrage,  often  results  in  widespread  political  cor- 
ruption. "  No  concealment  need  be  made  of  the  fact  that  the 
poll  tax  is  used  in  Mississippi  as  a  means  of  disqualifying  the 
negro  in  national  elections  and  controlling  the  vote  in  local 
elections."  l  The  aggregate  yield  of  the  poll  tax  is  small,  and 
the  expense  of  collecting  it  is  relatively  high.  It  has  few  de- 
fenders among  competent  students  of  taxation. 

1  C.  H.  Brough,  in  "  Studies  in  State  Taxation,"  Johns  Hopkins  University  Sludits 
in  Historical  and  Political  Science,  vol.  xviii,  p.  213. 


FEDERAL,   STATE,   AND   LOCAL  TAXES  735 

A  Balanced  Revenue  System 

There  are,  on  the  mainland  of  the  United  States,  forty-eight 
separate  sovereignties  in  addition  to  the  federal  government,  and 
the  resulting  conflicts  of  jurisdiction  gives  rise  to  the  deepest 
defects  of  our  revenue  system.  As  a  remedy  for  this  evil,  many 
authorities  recommend  a  division  or  separation  of  revenues,  by 
which  certain  taxes  would  be  assigned  to  the  federal  govern- 
ment, others  to  the  states,  and  still  others  to  the  local  govern- 
ments. This  plan  is  usually  referred  to  as  the  "  segregation  or 
separation  of  the  sources  of  revenue." 

The  benefits  that  might  be  derived  from  a  thoroughgoing 
system  of  segregation  are  many  and  obvious.  But  the  trend  of 
events  suggests  that  reform  must,  in  the  main,  be  sought  along 
other  lines.  The  boundaries  between  state  and  federal  finance 
become  more  indistinct  with  the  passage  of  time.  Both  federal 
and  state  governments  have  recently  adopted  income  taxes,  and 
the  federal  government  may  very  soon  deem  it  wise  to  adopt  the 
inheritance  tax.  The  state  governments  in  recent  years  have 
made  increasing  use  of  stamp  taxes  and  other  forms  of  excise 
taxation  theretofore  used  almost  exclusively  by  the  federal 
government.  In  commonwealth  finance,  similarly,  there  seems 
little  disposition  to  separate  clearly  the  sphere  of  state  and 
local  taxation.  On  the  contrary,  state  tax  commissions  are 
being  given  increasing  powers  of  regulating  local  taxation,  and 
it  is  being  recognized  in  increasing  degree  that  to  finance  the 
state  governments  by  corporation  and  indirect  taxes  which  do 
not  touch  the  great  mass  of  citizens  directly,  stimulates  ex- 
travagance on  the  part  of  the  state  legislature,  and,  in  fact, 
leads  to  the  reintroduction  by  the  state  of  direct  taxes  on 
general  property.  Furthermore,  there  are  some  manifest  ad- 
vantages in  the  joint  use  of  the  same  tax  by  several  divisions  of 
government.  The  central  or  larger  jurisdiction  not  only  finds 
it  possible  to  employ  expert  aid,  which  the  local  government 
could  not  afford  to  hire,  but  it  has  a  broader,  more  impartial 
point  of  view  which  serves  to  check  local  selfishness.  Local 
authorities,  on  the  other  hand,  frequently  have  a  helpful  knowl- 


736  OUTLINES  OF  ECONOMICS 

edge  of  important  facts  and  conditions  which  are  likely  to 
escape  the  agents  of  the  central  government.  Joint  use  of  the 
same  tax  also  permits  a  wise  compromise  between  central  effi- 
ciency and  the  American  demand  for  "  local  self-government." 

A  certain  amount  of  segregation  is,  however,  not  only  expe- 
dient but  plainly  necessary.  Thus,  the  use  of  import  and  export 
duties  is  confined  by  the  constitution  to  the  federal  government. 
In  the  domain  of  commonwealth  government  also  there  are  cer- 
tain enterprises,  such  as  sleeping  car  companies,  whose  property 
or  business  i;  so  difficult  to  localize  that  by  common  consent 
such  companies  are  reserved  for  state  taxation.  For  the  same 
reasons,  certain  other  corporations,  such  as  telephone,  telegraph, 
insurance,  freight  line  and  equipment  companies,  should  be,  and 
rapidly  are  being,  set  aside  for  state  or  central  taxation  ;  and  in 
the  case  of  most  "  state-wide  "  public  utilities  there  is  obvious 
need  for  central  assessment.  In  the  past,  it  was  common  to 
assess  separately  the  property  of  railroads  and  similar  public 
utilities  in  every  tax  district  (including  townships  and  even 
school  districts)  in  which  they  operated,  and  this  absurd  mor- 
cellement  is  still  practiced  in  some  backward  states/  including 
New  York.  Many  of  the  most  important  properties  of  such 
corporations  cannot  be  intelligently  valued  without  reference 
to  the  earnings  or  success  of  the  business  as  a  whole  and  this, 
as  well  as  considerations  of  administrative  simplicity,  makes 
valuation  or  assessment  as  a  unit  obviously  desirable.  When  the 
central  valuation  is  once  made  it  is  possible  in  some  cases  to 
distribute  or  apportion  the  valuation  to  counties  or  other  large 
local  subdivisions;  but  it  is  impossible  to  localize  some  busi- 
nesses satisfactorily,  and  minute  subdivision  is  in  all  cases  un- 
desirable. 

Much  that  has  been  said  above  about  state  versus  local 
assessment  applies,  in  the  case  of  interstate  corporations,  to  the 
question  of  federal  versus  state  assessment.  Without  federal 
control  each  state  is  tempted  to  select  that  form  of  taxation  and 
to  adopt  that  method  of  dividing  or  allocating  corporate  prop- 
erty and  business  for  purposes  of  taxation  which  is  most  bene- 
ficial to  itself.     Under  such  circumstances  some  interstate  cor- 


FEDERAL,   STATE,   AND   LOCAL  TAXES  737 

porations  are  taxed  upon  more  than  one  hundred  per  cent  of 
their  property  or  business,  while  others  take  advantage  of  the 
absence  of  authoritative  central  control  to  assign,  in  their  own 
accounting  systems,  excessive  proportions  of  property  and 
business  to  those  jurisdictions  in  which  taxes  are  lightest. 

While  federal  regulation  is  justified  by  the  same  logic  which 
sanctions  state  regulation  of  local  taxation,  it  is  very  doubtful 
how  far  federal  regulation  can  or  should  go.  If  the  national 
government  should  require  some  form  of  federal  incorporation 
for  companies  engaged  in  interstate  commerce,  it  is  possible 
that  it  would  have  power  thereafter  to  prescribe  the  methods 
by  which  such  interstate  companies  should  be  taxed  under  state 
law.  This  has  been  done  in  the  case  of  national  banks,  although 
the  power  of  the  federal  government  to  control  taxation  of 
national  banks  is  clearer  and  probably  greater  than  its  poten- 
tial power  to  limit  the  rate  of  taxation  of  ordinary  business  cor- 
porations engaged  in  interstate  commerce.  But  if  the  proposed 
federal  regulation  were  elastic  enough  to  permit  the  rate  of 
taxation  to  vary  in  each  state  with  the  average  level  or  burden 
of  taxation  in  that  state,  and  vigorous  enough  to  suppress  selfish 
state  aggrandizement,  it  would  represent  a  great  reform.  No 
form  of  federal  control  is  expedient,  however,  that  would  de- 
prive the  states  of  adequate  revenues  from  this  source.  The 
properties  of  interstate  companies  form  a  very  large  part  of 
existing  wealth.  In  a  number  of  states  one  tenth  or  more  of 
the  entire  taxes  collected,  state  and  local,  come  from  railroad 
companies  alone.  Commonwealth  revenue  systems  are  ad- 
justed to  this  condition  and  no  revolutionary  change  is  either 
practical  or  desirable. 

One  important  reform,  however,  could  be  accomplished  at 
once.  The  Interstate  Commerce  Commission,  or  some  similar 
federal  agency,  should  at  the  earliest  practicable  date  be  directed 
to  formulate  and  enforce  some  simple  plan  of  allocating  the 
revenues  and  expenses  of  interstate  corporations  to  the  several 
states  in  which  they  operate.  This  is  required  not  only  for  the 
fair  assessment  of  state  income  taxes,  but  for  the  valuation  of  the 
properties  of  interstate  corporations,  as  these  properties  can 

3B 


738  OUTLINES  OF   ECONOMICS 

never  be  satisfactorily  appraised  without  taking  their  earnings 
into  account. 

For  reasons  which  appear  in  the  preceding  discussion,  it  would 
be  misleading  to  formulate  any  clear-cut  division  of  taxes 
among  the  federal,  state,  and  local  governments.  A  few  forms 
of  revenue  will  unquestionably  be  reserved  for  the  use  of  one 
branch  of  government,  but  the  pressure  of  increasing  expendi- 
ture is  likely  to  force  a  joint  use  of  such  major  revenues  as  taxes 
on  real  estate,  income  and  inheritance  taxes,  excise  and  stamp 
duties ;  and  for  these  the  ideal  is  joint  administration,  in  which 
the  relative  impartiality  and  vigor  of  central  administration 
may  be  supplemented  and  perfected  by  the  more  intimate 
knowledge  of  local  officials. 

QUESTIONS 

i.  Why  are  the  terms  "direct"  and  "indirect"  taxes  particularly  vague 
and  equivocal? 

2.  Explain  why  no  protection  is  given  the  home  producer  when  the  im- 
port duty  is  shifted  upon  the  foreigner. 

3.  What  is  the  greatest  fiscal  defect  of  American  customs  taxation  ?  Can 
this  defect  be  remedied? 

4.  Are  excise  taxes  ethically  justifiable?  Do  they  materially  check  con- 
sumption when  imposed  upon  alcoholic  beverages  and  tobacco? 

5.  Do  you  know  of  any  state  which  levies  an  income  tax  at  the  present 
time?     Is  the  tax  successful? 

6.  Should  income  which  is  saved  and  immediately  reinvested  be  taxed? 
Is  it  not  double  taxation  to  tax  savings  and  the  earnings  from  such  savings 
as  well  ? 

7.  Should  corporations  be  taxed  at  the  same  rate  as  unincorporated 
business  concerns?  Should  any  definite  relation  between  the  two  kinds  of 
taxes  be  maintained? 

8.  Contrast  the  taxation  of  national  banks  in  your  own  state  with  the 
taxation  of  trust  companies,  ordinary  commercial  or  manufacturing  corpora- 
id  unincorporated  business  concerns. 

9.  Slate  as  many  reasons  as  possible  why  the  separation  of  state  and 
local  revenues  would  be  helpful. 

10.  Explain  why  many  forms  of  property  employed  in  business  cannot 
be  intelligently  assessed  for  taxation  without  reference  to  the  earnings  of  the 
business. 

11.  Are  assessors  elected  or  appointed  in  your  own  state?  Do  they  re- 
quire taxpayers  to  declare  their  personal  property  in  great  detail?    Do  the 


FEDERAL,    STATE,   AND   LOCAL   TAXES  739 

local  assessment  rolls  contain  separate  figures  for  real  estate  and  improve- 
ments?   Is  the  property  of  nonresidents  specially  designated? 

12.  Why  is  the  general  property  tax  particularly  unsuited  to  the  taxation 
of  business  and  professional  men? 

13.  Should  the  federal  government,  if  it  possesses  the  power,  make  the 
taxation  of  interstate  commerce  corporations  uniform  throughout  the  United 
States? 

REFERENCES 

Buxlock,  C.  J.  Selected  Readings  in  Public  Finance,  Chaps,  vii-xix;  "The 
Taxation  of  Corporations  in  Massachusetts,"  Quarterly  Journal  of 
Economics,  Vol.  xxi,  pp.  181-246. 

Commissioner  of  Corporations.  Reports  on  the  Taxation  of  Corporations ; 
Special  Report  on  Taxation. 

Ely,  R.  T.  Property  and  Contract  in  tlicir  Relations  to  the  Distribution  of 
Wealth,  Chap.  xvii. 

Hollander,  J.  H.  (ed.),  "Studies  in  State  Taxation,''  Johns  Hopkins 
University  Studies  in  Historical  and  Political  Science,  Series  xviii. 

Industrial  Commission.  Report.  "Taxation,"  Vol.  xix,  pp.  1031-1069; 
"Taxation  in  Various  States  and  in  Canada  with  Special  Reference 
to  the  Taxation  of  Corporations,"  Vol.  xi,  Part  vii;  "Taxation  of 
Transportation  Companies,"  Vol.  ix,  pp.  1006-1091. 

Reports  of  State  Tax  Commissions.  Upon  the  topics  indicated  see  "The 
Massachusetts  Tax  System  and  its  Workings,"  Massachusetts  Com- 
mission of  1897,  pp.  1-73;  "Public  Service  Corporations,"  Wisconsin 
Commission,  1901,  pp.  72-121 ;  "Taxation  of  Credits,"  ibid.,  1903,  pp. 
88-144;  "Mortgage  Taxation,"  ibid.,  1907,  pp.  303  el  seq.;  "Railway 
Taxation,"  Ontario  Commission,  1905  ;  Committee  on  Taxation  of  the 
City  of  New  York,  1915 ;  Massachusetts  Special  Commission  on  Taxa- 
tion, 191 5. 

Seligman,  E.  R.  A.     The  Income  Tax. 

West,  Max.     The  Inheritance  Tax,  Chaps,  vii  and  ix. 


APPENDIX  A 

HISTORY  OF   ECONOMIC  THOUGHT 

Economic  Ideas  in  the  Ancient  World.  —  The  assertion  is  some- 
times made,  or  at  least  the  impression  is  frequently  given,  that  there 
were  no  writings  on  economics  before  Adam  Smith.  This  impression 
is  erroneous,  and  derives  its  plausibility  from  the  fact  that  before 
Adam  Smith  economic  subjects  were  treated  either  disjointedly 
and  in  a  monographic  way,  or  else  in  connection  with  ethics  and 
political  philosophy.  But  in  treating  economics  in  connection 
with  ethics  and  politics,  the  older  writers  were  merely  following  an 
instinctive  method  of  dealing  with  economic  truths,  to  which  in  a 
certain  degree  later  writers  are  returning.  Indeed,  if  we  are  to 
derive  the  utmost  possible  benefit  from  this  brief  survey  of  the  devel- 
opment of  economic  thought,  it  is  necessary  to  begin  many  cen- 
turies before  Adam  Smith,  with  the  Greeks. 

The  Greeks.  —  The  three  writers  among  the  Greeks  most  inter- 
esting to  the  economist  are  Plato,  Aristotle,  and  Xenophon.  Both 
Xenophon  and  Aristotle  (or,  more  probably,  some  unknown  dis- 
ciple of  Aristotle)  have  treatises  upon  the  specific  subject  of  (Eco- 
nomics, but  these  are  devoted  principally  to  domestic  economy,  or 
the  management  of  the  household ;  and  the  more  important  eco- 
nomic ideas  of  the  Greek  writers  are  derived  from  their  works  which 
deal  primarily  with  political  and  ethical  subjects. 

Plato  describes  a  Utopia  in  his  Republic.  His  aim  was  to  picture 
an  ideal  society  in  which  the  ills  of  society  were  to  be  corrected  by 
a  communistic  State,  and  he  included  a  communism  even  of  wives 
and  children,  going  farther  than  modern  communists.  The  com- 
munism of  Plato  admitted,  strange  as  it  may  seem,  slavery,  on 
which  his  social  superstructure  indeed  rested  as  a  base.  The  Laws 
of  Plato  is  a  more  practical  work.  It  aims  to  present  not  the  best 
possible  state,  but  a  more  practicable  one,  and  deals  to  a  greater 
extent  with  existing  institutions. 

Aristotle's  principal  work  for  us  is  the  Politics,  and  it  is  indeed 
one  of  the  most  remarkable  books  in  the  world's  history.  Its  in- 
fluence is  strongly  felt  today,  for  it  was  carefully  studied  by  theo- 
logians of  the  Middle  Ages,  and  through  them  entered  into  the  thought 
and  life  of  their  time ;  and  the  thought  and  life  of  their  time  can  be 
seen  by  the  careful  student  to  have  entered  in  a  thousand  ways  into 
the  institutions  of  the  twentieth  century. 

While  Plato  tacitly  accepted  slavery,  Aristotle  actively  defended 
the  institution  of  slavery,  describing  the  slave  as  an  "  animated 

741 


742 


OUTLINES   OF   ECONOMICS 


tool,"  and  insisting  that  slave  labor  was  necessary  in  order  that  the 
ruling  classes  might  have  the  leisure  for  statecraft,  art,  and  litera- 
ture. Both  Plato  and  Aristotle,  also,  fully  appreciated  the  advan- 
tages of  the  division  of  labor,  and  understood,  in  consequence,  that 
a  certain  amount  of  traffic  and  exchange  is  necessary.  But  both 
writers  shared  the  common  prejudice  against  trade  and  commerce; 
what  one  man  gained  in  exchange,  they  thought,  some  other  man 
lost ;  and  to  live  by  trade  was  in  their  eyes  despicable.  Aristotle, 
moreover,  defended  the  institution  of  private  property,  and  formu- 
lated surprisingly  accurate  ideas  about  money  and  its  functions; 
but  he  condemned  interest  taking  because,  as  he  expressed  it,  money 
is  barren. 

Perhaps  the  most  characteristic  quality  of  Greek  economic  thought, 
speaking  generally,  is  the  thorough  subordination  of  economic  to 
ethical  and  political  considerations.  The  object  of  life,  in  their 
view,  was  self-knowledge  or  self-realization,  not  the  acquisition 
of  riches,  and  they  refused  to  regard  wealth  as  an  object  of  funda- 
mental importance  to  either  the  individual  or  the  State.  Plato, 
indeed,  in  certain  parts  of  his  writings,  defends  the  ascetic  idea  that 
human  wants  are  to  be  satisfied,  not  by  the  improvement  of  produc- 
tive processes,  but  by  the  repression  of  the  wants  themselves. 

The  Romans.  —  While  the  economic  institutions  of  the  Romans 
and  the  manifestations  of  their  character  in  their  economic  life  will 
repay  investigation,  they  were  not  remarkable  for  independent 
thought.  Their  economic  ideas,  like  their  philosophical  doctrines, 
were  borrowed  from  the  Greeks,  and  show  the  same  general  char- 
acteristics which  the  ideas  of  Plato  and  Aristotle  do.  Commerce 
and  trade  were  held  in  contempt,  particularly  when  carried  on  in  a 
small  way.  Interest  taking  was  by  some  thought  to  be  "  as  bad 
as  murder."  Agriculture,  on  the  other  hand,  was  esteemed  to  be 
worthy  of  the  noblest  citizens,  and  a  "  return  to  the  soil  "  in  later 
Roman  times  was  frequently  recommended  as  a  cure  for  the  pre- 
vailing degeneracy.  Pliny  said  the  great  estates,  the  latifundia, 
together  with  slave  labor  and  the  destruction  of  the  small  inde- 
pendent farmer,  caused  the  downfall  of  Rome.  Among  other  agri- 
cultural problems  discussed  by  the  Romans  were  those  of  intensive 
versus  extensive  culture,  and  slave  versus  free  labor. 

'I  he  jurists  are,  however,  the  most  important  of  all.  Whatever 
may  be  its  imperfections,  the  Roman  law,  the  corpus  juris  civilis, 
is  the  most  remarkable  legal  system  the  world  has  ever  seen  and 
tor  training  in  careful  and  accurate  statement  is  unsurpassed.  Prob- 
ably, as  a  training  for  economic  studies,  Roman  law  is  among  the 
most  valuable  branches  of  learning.  It  gives  us  also  invaluable 
information  about  the  economic  institutions  of  Rome. 

Christianity. — To  the  economic  thought  of  the  time  Chris- 
tianity brought  the  revolutionary  ideas  of  the  dignity  of  toil  and 
the  equality  of  men  before  God.  The  philosophy  of  the  Stoics  had 
brought  analogous  ideas  to  the  attention  cf  the  restricted  intellectual 
world  of  the  day,  but  Christianity  popularized  these  ideas.    The 


APPENDIX  743 

clergy  were  encouraged  to  earn  their  livelihood  by  manual  labor, 
and  laymen  were  exhorted  to  free  their  slaves  as  soon  as  they  had 
become  Christians.  Wrth  respect  to  money  and  trade,  however,  the 
effect  of  Christianity  was  to  strengthen  and  impress  the  teachings  of 
Aristotle. 

The  Middle  Ages.  —  As  the  power  of  the  Church  increased,  its 
economic  ideas  found  more  formal  expression  in  the  treatises  of 
the  schoolmen  and  medieval  theologians  who  expounded  the  church 
or  canon  law.  Indeed,  in  the  corpus  juris  canonici  we  have  a  definite 
system  of  economic  thought  which,  while  it  was  largely  theoretical 
and  intended  originally  for  the  ecclesiastical  courts,  came  in  time 
to  be  widely  applied  in  secular  affairs  through  the  power  of  the  con- 
fessional, the  pulpit,  and  the  wide  jurisdiction  of  the  ecclesiastical 
courts. 

The  doctrines  of  the  canonists  were  derived,  in  part,  from  bib- 
lical injunctions  against  usury  and  the  pursuit  of  wealth.  The 
early  Christian  fathers  frequently  went  so  far  as  to  condemn  private 
property  and  set  up  the  ideal  of  communism  among  the  faithful. 
But  this  was  only  an  ideal,  and  private  property  was  early  recog- 
nized as  a  necessary  evil  resulting  from  the  fall  of  man.  This  ideal, 
however,  was  powerful  enough  to  keep  alive  the  doctrine  that  the 
maintenance  of  the  poor  was  not  a  matter  of  philanthropy,  but  a 
binding  obligation,  in  the  words  of  Thomas  Aquinas,  the  most  dis- 
tinguished canonist,  a  debitum  legale. 

Following  the  philosophers  of  Greece  and  Rome,  and  in  sym- 
pathy with  the  scriptural  attitude  toward  wealth,  trade  and  com- 
merce were  regarded  as  greatly  inferior  to  agriculture  and  handi- 
work as  a  source  of  livelihood.  It  was  still  believed  that  what  the 
seller  made  by  trade  the  buyer  necessarily  lost.  As  commerce 
developed,  however,  trade  had  to  be  recognized  by  the  Church. 
In  doing  so,  the  canon  writers  formulated  the  doctrine  of  justum 
prctium,  that  every  commodity  has  a  just  price,  or  value,  which  it 
is  sinful  for  the  seller  to  exceed.  The  modern  trade-union  doc- 
trine of  a  fair  wage,  and  the  decisions  of  our  courts  concerning  rea- 
sonable charges  for  gas,  railway  services,  etc.,  illustrate  the  perma- 
nent necessity  of  ethical  ideas  of  this  sort. 

The  next  most  important  economic  doctrine  of  the  canonists 
was  the  condemnation  of  usury,  which  originally  signified  any  loan 
interest,  and  not  necessarily  excessive  interest.  Their  argument 
against  interest  was  based  upon  scriptural  strictures  against  usury, 
and  upon  Aristotle's  argument  that  money  is  barren.  Interest 
taking  by  the  clergy  had  been  prohibited  as  early  as  the  fourth 
century;  but  in  1311,  at  the  Council  of  Vienna,  interest  was  pro- 
hibited "absolutely  and  universally,"  regardless  of  the  civil  law; 
and  by  the  middle  of  the  fourteenth  century,  the  prohibition  of 
interest  had,  in  many  places,  been  incorporated  into  the  civil  law. 
Little  by  little,  however,  the  Church  was  forced  to  change  its  atti- 
tude, and  in  the  middle  of  the  sixteenth  century  (1545)  a  statute 
was  passed  in  England  legalizing  an  annual    interest  rate  not   in 


744  OUTLINES  OF   ECONOMICS 

excess  of  10  per  cent.1  By  this  time  the  teachings  of  the  canonists 
were  fast  giving  way  to  the  doctrines  of  mercantilism. 

Economic  Ideas  in  Modern  Times.  —  Before  the  close  of  the 
sixteenth  century,  the  temporal  power  of  the  Church  had  been 
undermined  by  the  development  of  the  great  modern  monarchies, 
and  in  economic  thought  religious  considerations  were  replaced  by 
political  necessities.  The  problem  of  the  Church  —  the  universal 
establishment  of  the  Kingdom  of  God  upon  earth  —  gave  way  to  a 
newer  problem  —  the  maintenance  and  aggrandizement  of  rival 
states.  The  latter  were  in  pressing  need  of  ready  money  with  which 
to  build  navies  and  support  armies.  How  to  increase  public  revenue 
and  national  wealth  became  the  absorbing  questions  of  the  time. 

Mercantilism.  —  The  mercantile  system,  also  called  Colbert- 
ism,  restrictive  system,  and  commercial  system,  obtained  from 
the  early  part  of  the  sixteenth  century  until  late  in  the  eighteenth 
century,  and  its  influence  is  still  felt.  Mercantilism  is  not,  strictly 
speaking,  the  product  of  a  school  of  political  economists,  but  rather 
the  name  given  to  that  economic  policy  of  statesmen  and  to  those 
detached  economic  views  of  writers  which  prevailed  during  this 
period.  Most  prominent  among  the  statesmen  who  were  mercantil- 
ists may  be  named  Colbert,  of  France,  Frederick  the  Great,  of  Prussia, 
and  Cromwell,  of  England.  Serra,  an  Italian,  early  in  the  seventeenth 
century  presented  a  moderate  and  systematic  statement  of  their  views 
in  a  work  entitled  A  Brief  Treatise  on  Causes  which  make  Gold  and 
Silver  abound  where  there  are  no  Mines.  Thomas  Mun,  in  England, 
a  generation  later,  wrote  a  valuable  treatise  from  the  standpoint 
of  the  mercantilists,  called  England's  Treasure  by  Foreign  Trade:  or 
the  Balance  of  our  Trade  the  Rule  of  our  Treasure,  while  Sir  James 
Steuart's  Inquiries  into  the  Principles  of  Political  Economy,  published 
in  1767,  may  be  regarded  as  closing  the  development  of  the  theory 
of  mercantilism. 

The  principal  characteristics  of  mercantilism  —  the  efforts  to 
increase  the  stock  of  precious  metals  within  the  country,  to  main- 
tain a  favorable  balance  of  trade,  to  increase  the  population  and 
foster  manufactures,  if  necessary  at  the  expense  of  agriculture  — 
have  been  described  elsewhere,  and  need  not  be  repeated  at  this 
point.  In  attempting  to  apply  these  theories,  however,  the  states- 
men of  this  epoch  instinctively  turned  to  that  instrument  —  the 
law  —  with  whose  use  they  were  most  familiar,  and  statutory  re- 
strictions were  multiplied  until  mercantilism  in  one  sense  became 
practically  synonymous  with  governmental  interference.  Toward 
the  end  of  the  eighteenth  century,  however,  the  commercial  posi- 
tion of  England,  for  example,  became  so  strong  that  many  of  her 
industries  found  themselves  crippled  and  confined  by  the  very  laws 
which  had  protected  their  infancy,  and  a  reaction  against  mercan- 
tilism set  in.  The  reaction,  naturally,  took  the  form  of  a  movement 
in  favor  of  agriculture  and  against  governmental  interference  in 
economic  and  industrial  affairs.  In  obedience  to  the  needs  of  a  new 
1  See  also  p.  493,  above. 


APPENDIX  745 

epoch,  political  economy  lent  itself  to  a  propaganda  in  support  of  the 
doctrine  of  industrial  liberty. 

The  Physiocrats.  —  The  reaction  against  mercantilism  found  its 
first  thorough  and  scientific  expression  at  the  hands  of  the  French 
physiocrats.  Quesnay,  a  physician,  Gournay,  a  merchant,  and 
Turgot,1  the  statesman,  are  their  three  principal  authors.  Polit- 
ically, the  physiocrats  taught  the  doctrine  of  natural  laws  and 
rights,  and  as  a  consequence  loudly  proclaimed  the  maxim  of  laissez- 
faire,  that  is,  that  the  government  should  not  interfere  with  pri- 
vate enterprise.  Economically,  they  exalted  the  importance  of 
agriculture,  and  maintained  that  manufactures  and  commerce, 
which  merely  change  the  form  or  position  of  raw  materials,  are 
barren  and  unproductive  (though  useful  when  subordinated  to 
agriculture) ;  but  that  agriculture  yields  a  net  surplus  —  produit 
net  —  over  and  above  the  expenses  of  production.  The  physio- 
crats must  thus  be  credited  with  originating  the  fertile  economic 
doctrine  of  surplus  value  —  a  reward  or  premium  appearing  in  pro- 
duction for  which  nature  rather  than  man  is  responsible,  and  which 
is  not  required  to  induce  men  to  put  forth  the  effort  necessary  to 
produce  wealth. 

Many  of  the  other  doctrines  of  the  physiocrats  follow  logically 
from  the  primacy  which  they  accorded  to  agriculture.  Since  agri- 
culture is  the  sole  ultimate  source  of  wealth,  they  maintained  that 
the  revenue  of  the  State  should  be  raised  by  a  single  direct  tax  — 
the  impdt  unique  —  levied  upon  land.  All  taxes  must,  they  thought, 
in  the  end  come  out  of  rent  anyway  ;  and  it  was  better  that  the  land- 
lord should  pay  them  at  once  instead  of  waiting  until  they  had 
passed  through  five  or  six  hands  and  various  profits  had  added  to 
their  amount.  Naturally  the  physiocrats  were  ardent  champions 
of  free  trade.  They  encouraged  also  the  consumption  of  agricultural 
products,  "  in  order  that  the  produit  net  might  be  increased,"  and 
were  generous  champions  of  the  importance  and  rights  of  the  down- 
trodden peasantry.  Pauvres  paysans,  pauvre  royaume;  pauvre 
rgyaume,  pauvre  roi,  was  the  borrowed  motto  of  Quesnay's  Tableau 
Economique,  the  most  important  treatise  of  the  physiocratic  school. 

Adam  Smith.  —  In  1776  Adam  Smith  published  his  Inquiry  into 
the  Nature  and  Causes  of  the  Wealth  of  Nations,  the  most  influential 
economic  treatise  ever  written.  "  The  life  of  almost  everyone  in 
England,  perhaps  of  everyone,"  said  Bagehot,  "  is  different  and 
better  in  consequence  of  it."  His  writings  are  found  to  be  very 
similar  to  those  of  the  physiocrats,  but  further  developed  and  modi- 
fied by  his  Scotch  training  and  habit  of  mind.  We  find  in  Adam 
Smith  the  doctrines  of  free  trade,  non-interference,  and  natural 
laws,  yet  all  stated  more  guardedly.  Although  he  does  not  regard 
agriculture  as  exclusively  productive,  he  does  show  a  partiality  for 
agriculture,  for  in  this  branch  of  production,  he  says,  nature  labors 

1  Turgot  did  not  count  himself  a  member  of  the  economic  sect  or  school  which 
Rave  their  views  the  name  of  "physiocracy,"  but  his  economic  doctrines  are  very 
much  like  theirs. 


746  OUTLINES  OF  ECONOMICS 

along  with  man.  He  emphasized  the  importance  of  permitting 
each  individual  to  follow  his  own  self-interest  as  a  means  of  pro- 
moting national  prosperity,  but  he  was  not  unmindful  of  the  exist- 
ence of  altruistic  motives  in  mankind.  He  accords  full  recognition 
to  the  motives  of  sympathy  and  kindness  in  his  Theory  of  Moral 
Sentiments.  But  the  net  result  of  Smith's  teaching  was  to  strengthen 
and  emphasize  the  laissez-faire  trend  of  economic  thought  in  his 
time.  "  Two  conceptions,"  said  Arnold  Toynbee,  "  are  woven 
into  every  argument  of  the  Wealth  of  Nations,  the  belief  in  the  su- 
preme value  of  individual  liberty,  and  a  conviction  that  man's  self- 
love  is  God's  providence,  that  the  individual  in  pursuing  his  own 
interest  is  promoting  the  welfare  of  all." 

Economic  Thought  in  the  Nineteenth  Century.  —  Tlie  Classical 
School.  —  The  economic  philosophy  which  prevailed  during  the 
first  half  of  the  nineteenth  century  is  variously  designated  as  the 
classical,  Ricardian,  English,  or  orthodox  school.  The  earlier 
authors  of  this  period  were  Jeremy  Bentham  (i  748-1832),  Thomas 
Robert  Malthus  (1766-1834),  David  Ricardo  (1772-1S23),  James 
Mill  (1773-1836),  and  John  Ramsay  McCulloch  (1779-1864).  In 
all  of  these  writers  we  find  the  utilitarian  philosophy,  a  deductive 
method,  and  the  feeling  that  the  outlook  for  the  mass  of  the  laborers 
was  not  a  hopeful  one.  They  elaborated  economic  principles,  sup- 
posed to  be  good  for  all  times  and  places,  with  the  positiveness  that 
one  expects  to  find  only  in  the  mathematical  or  physical  sciences. 

Bentham's  great  work  was  the  formulation  and  propaganda  of 
the  utilitarian  ethics,  with  its  famous  first  principle  or  goal  of 
social  action  —  the  greatest  happiness  of  the  greatest  number. 

Malthus 's  principal  contribution,  contained  in  his  celebrated 
work,  The  Theory  of  Population,  has  already  been  discussed.  While 
Malthus  was  himself  a  particularly  charitable  and  benevolent  friend 
of  the  working  classes,  his  doctrine  of  population  contributed  more 
than  any  other  single  thing  to  make  the  political  economy  of  the 
classical  school  harsh  and  gloomy.  It  seemed  to  say  that  although 
wages  were  low  they  could  be  no  higher,  because  if  by  some  fortunate 
chance  wages  increased,  population  was  sure  to  multiply  until  the 
wage  was  forced  back  to  the  old  level.  Poor  relief  and  trade- 
union  activities  were  both  useless.  The  woe  of  the  poor  was  due  to 
their  own  lack  of  foresight,  and  could  be  removed  by  the  poor  alone. 
It  was  taught  "  that  he  who  brought  children  into  the  world  without 
adequate  provision  for  them  should  be  left  to  the  punishment  of 
nature."  The  responsibility  of  poverty  was  thus  thrust  upon  the 
poor  themselves ;  the  rich  were  soothed  with  the  assurance  that  they 
were  not  primarily  responsible  for  the  condition  of  affairs.  Malthus 
himself,  however,  did  not  frame  his  doctrine  in  so  remorseless  a  way. 
He  recognized  the  importance  of  what  he  called  "  preventive  checks  " 
to  the  increase  of  the  population.  Malthus  brought  the  results  of 
elaborate  historical  and  statistical  investigations  to  the  support  of  his 
doctrines. 

Ricardo  was  perhaps  the  first  economist  who  adequately  realized 


APPENDIX  747 

the  importance  of  the  problem  of  the  distribution  of  wealth.  The 
backbone  of  his  distributive  system  was  the  Malthusian  law  of  pop- 
ulation. Ricardo  believed  that  as  population  increased,  society 
would  be  forced  to  resort  to  poorer  and  poorer  soils  in  order  to  ob- 
tain food ;  and  as  this  took  place  an  increasing  share  of  the  product 
of  industry  would  go  to  the  landlord  in  the  shape  of  economic  rent. 
The  division  of  the  remaining  product  between  labor  and  capital, 
in  Ricardo 's  view,  was  determined  largely  by  the  standard  of  living; 
that  is  to  say,  the  laborer  would  receive  enough  to  purchase  the 
necessaries  and  conveniences  required  to  support  him  and  his  family 
in  their  customary  style  of  living,  while  the  residue  would  go  to 
capital  in  the  form  of  interest  and  profits.  Profits  were  thus  the 
"  leavings  of  wages."  With  the  passage  of  time  and  the  settlement 
of  a  country,  then,  Ricardo's  theory  of  distribution  taught  that 
rent  would  absorb  a  larger  and  a  larger  share  of  the  product,  wages 
a  constant  or  slowly  increasing  amount,  while  profits  would  dwindle 
both  absolutely  and  relatively.  , 

Ricardo's  principal  work  is  called  Principles  of  Political  Economy 
and  Taxation.  It  was  published  in  1817,  and  in  it  Ricardo  elaborates, 
although  he  did  not  originate,  the  usually  received  doctrine  of  rent, 
which,  modified  and  developed,  is  the  one  presented  in  this  book. 
His  ideas  in  general  have  a  markedly  pessimistic  tinge.  Rent, 
he  said,  is  due  to  the  niggardliness,  not  to  the  bounty,  of  nature ; 
and  his  theory  of  distribution  emphasized  the  natural  diversity  of 
interest  between  wage  receivers  and  profit  makers,  and  the  antago- 
nism between  the  interests  of  landowners  and  all  other  classes  of 
society.  Personally  he  was  a  kind  man,  and  sincerely  devoted 
to  the  advancement  of  humanity.  Ricardo  is  remarkable  for  his 
power  in  the  use  of  the  abstract  deductive  method,  and  it  is  note- 
worthy that  this  distinction  should  attach,  not  to  a  professional 
scholar,  but  to  one  of  the  most  successful  bankers  and  brokers  of 
his  day. 

John  Stuart  Mill,  who  lived  from  1806-1873,  closed  one  period 
in  the  development  of  economic  science  and  began  another  in  Eng- 
land. He  started  as  a  thoroughgoing  follower  of  Ricardo,  pre- 
served the  old  doctrines  of  value,  rent,  and  profits,  and  advocated 
laissez-faire  as  a  general  principle  of  political  expediency.  But 
in  his  later  years  Mill  advocated  the  diffusion  of  property  through 
the  regulation  and  taxation  of  inheritances,  indorsed  the  appro- 
priation by  the  State  of  the  future  unearned  increment  of  land,  and 
emphasized  an  important  distinction  between  the  production  and 
distribution  of  wealth.  "  The  laws  and  conditions  of  the  produc- 
tion of  wealth,"  he  said,  "  partake  of  the  nature  of  physical  truths. 
There  is  nothing  optional  or  arbitrary  in  them.  ...  It  is  not  so 
with  the  distribution  of  wealth.  That  is  a  matter  of  human  insti- 
tutions solely.  The  things  once  there,  mankind,  individually  or 
collectively,  can  do  with  them  as  they  like.  .  .  .  The  distribution 
of  wealth,  therefore,  depends  upon  the  laws  and  customs  of  society. 
The  rules  by  which  it  is  determined  are  what  the  opinions  and  feelings 


748  OUTLINES  OF  ECONOMICS 

of  the  community  make  them,  and  are  very  different  in  different 
ages  and  countries;  and  might  be  still  more  different,  if  mankind 
so  choose." 

The  old  and  the  new  doctrines  found  in  Mill's  Principles  of  Polit- 
ical Economy  do  not  harmonize,  however,  and  the  result  is  a  work 
one  of  the  most  valuable  of  modern  times,  yet  full  of  inconsistencies. 
Nevertheless,  Mill  will  always  be  regarded  as  the  culmination  of 
the  school  usually  known  as  the  English  deductive  or  classical  school. 
Most  of  the  work  of  the  school  was  deductive ;  that  is,  they  reasoned 
by  singling  out  a  few  main  facts  of  the  external  physical  world  and 
human  nature  familiar  to  all,  and  showing  how  men  must  act  under 
the  guidance  of  these  laws.  None  of  these  economists  pretended 
that  the  few  laws  which  they  considered  were  the  whole  of  human 
nature,  though  they  have  sometimes  been  interpreted  as  if  they  did 
so ;  but  they  thought  that  the  great  multitude  of  motives  which 
influenced  men  were  too  complex  to  be  analyzed,  and  only  one  or 
two  (chiefly  self-interest)  could  "  be  reduced  to  any  assignable  law." 
Despite  these  limitations,  the  largest  contributions  that  have  been 
made  to  economic  science  came  from  the  English  classical  school. 

Socialism.  —  Mill's  change  of  heart  resulted  partly  from  his 
study  of  the  socialist  writers,  who  voiced  the  earliest  and  most 
thoroughgoing  protest  against  the  views  of  the  classical  economists. 
Modern  socialistic  doctrine  may  conveniently  be  dated  from 
William  Godwin's  Inquiry  concerning  Political  Justice  (1793),  al- 
though Godwin  himself  was  more  of  an  anarchist  than  a  socialist. 
Godwin  and  the  early  French  idealists  and  communists,  —  Cabet, 
Saint-Simon,  Fourier,  etc.,  —  began  the  attack  on  the  ethical  and 
political  views  of  the  orthodox  political  economy.  Later  the  attack 
was  continued  in  a  somewhat  more  practical  and  realistic  way  by 
writers  such  as  William  Thompson  and  Robert  Owen  in  England, 
Bazard  and  Louis  Blanc  in  France,  Rodbertus,  Lasalle,  and  Marx  in 
Germany.  The  foundation  of  classical  political  economy  was  laissez- 
faire,  and  its  doctrinal  structure  was  built  around  the  system  of  private 
capitalistic  enterprise.  Socialism  in  essence  was  a  thorough  protest 
against  laissez-faire  and  the  private  ownership  of  property.  Pierre 
Le  Roux  used  the  word  "  socialism  "  in  1838  *  with  the  very  purpose 
of  expressing  the  antithesis  of  individualism. 

In  recent  times,  largely  under  the  influence  of  Karl  Marx,  social- 
ism has  acquired  a  distinctive  economic  theory  of  its  own.  Marx, 
in  his  work  on  Capital,  was  in  most  ways  as  abstract,  deductive,  and 
pessimistic  as  any  of  the  classical  school,  but  at  bottom  his  whole 
theory  was  directed  against  those  fundamental  institutions  of  our 
social  order  which  the  classical  economists  took  for  granted.  Marx 
has  been  credited  by  some  with  the  discovery  of  the  materialistic  or 
economic  interpretation  of  history,  and  the  whole  tendency  of  the 
modern  scientific  socialists  has  been  to  emphasize  the  evolutionary 
standpoint. 

The    Sociologists.  —  Among  other    influences  which    broadened 

1  It  was  used  before  this  in  England  by  the  followers  of  Robert  Owen. 


APPENDIX  749 

Mill's  conception  of  economic  science,  and  induced  him  to  temper 
the  rigor  of  his  early  teachings,  were  the  works  of  Auguste  Comte 
(i 798-1857),  the  founder  of  modern  sociology.  Comte  was  espe- 
cially severe  in  his  criticism  of  the  methods  of  the  classical  econo- 
mists. He  denied,  in  particular,  that  it  is  possible  to  develop  a 
helpful  science  of  economics  distinct  from  history,  ethics,  and  poli- 
tics. Not  only  must  these  fields,  he  maintained,  be  cultivated  in 
common,  but  the  work  must  be  done  by  inductive,  as  distinct  from 
deductive,  methods.  To  the  classical  assumption  that  a  universal 
science  of  economics  could  be  formulated,  true  for  all  times  and 
places,  he  opposed  the  theory  that  there  is  in  society  an  ordered 
change  or  evolution,  and  that  the  capitalistic  stage,  to  which  the 
classical  economics  conformed,  must  be  studied  in  connection  with 
the  past  and  the  future.  Economics,  he  particularly  insisted,  cannot 
be  divorced  from  history. 

The  Historical  School.  —  This  particular  line  of  thought  was 
taken  up  in  Germany  about  1850  by  three  young  Germans, 
Roscher,  Knies,  and  Hildebrand,  who  vigorously  assailed  the  doc- 
trines of  the  classical  school.  They  went  back  to  the  old  premises 
—  self-interest,  private  property,  demand  and  supply  —  and  traced 
out  the  historical  development  of  economic  life,  coming  to  the  con- 
clusion that  economic  policies  were  not  absolutely,  but  only  rela- 
tively, true.  They  denied  that  economic  science  can  discover  laws 
which  hold  true  for  all  times  and  all  places.  They  emphasized 
the  importance  of  the  inductive  method,  of  minute  investigations 
into  facts,  and  the  study  of  legal  institutions,  custom,  and  ethics 
in  their  relation  to  economic  life,  while  most  members  of  the  school 
entertained  a  strong  sympathy  for  policies  of  reform. 

Owing  to  the  political  ferment  in  Germany  during  the  infancy 
of  the  historical  school  and  the  formation  of  the  German  Empire 
when  this  reaction  against  the  classical  economists  was  at  its  height, 
German  political  economy  of  the  last  half  of  the  nineteenth  century 
was  impregnated  with  a  striking  nationalistic  spirit  which  sepa- 
rated it  even  further  from  the  cosmopolitanism  of  the  English  writers. 
The  creation  of  a  new  state  is  almost  invariably  attended  by  the 
enactment  of  restrictive  legislation,  looking  to  the  amalgamation 
of  the  diverse  elements  incorporated  into  the  new  state  and  the 
protection  of  its  industries  from  foreign  competition.  Laissez- 
faire,  under  these  conditions,  is  particularly  difficult  to  maintain. 
The  new  national  economy  of  Germany  seemed  to  voice  these  politi- 
cal necessities.  Like  the  classical  economy  of  England,  it  was  a 
creature  of  its  own  time  and  its  own  environment. 

The  Economic  Optimists.  —  The  classical  English  economists 
have  often  been  called  pessimists.  This  is  too  strong  a  term,  in- 
asmuch as  they  all  saw  hope  for  improvement.  What  can  be  said 
is  that  they  developed  pessimistic  tendencies.  Take  it  as  we  will, 
the  Malthusian  doctrine  of  population  is  tinged  with  pessimism, 
and  so  also  is  the  Ricardian  theory  of  distribution.  In  oppo- 
sition to  English  economists,  there  was  developed  elsewhere,  about 


75o  OUTLINES  OF  ECONOMICS 

the  middle  of  the  nineteenth  century,  a  scheme  of  thoroughgoing 
economic  optimism,  and  this  was  presented  in  a  more  unqualified 
way  by  Frederic  Bastiat  (1801-1850),  than  by  any  one  else.  Bastiat 
was  an  ardent  agitator  for  free  trade  and  a  popular  pleader  for  the 
existing  order  against  the  attacks  of  socialists  and  anarchists,  he  was 
the  author  of  numerous  pamphlets,  and  at  the  time  of  his  death 
was  engaged  on  a  systematic  treatise  entitled  Economic  Harmonies, 
of  which  the  first  volume  only  was  completed.  According  to 
Bastiat,  there  is  no  economic  rent.  The  landowner  does  not 
receive  an  unearned  income.  What  we  call  rent  is  simply  a  return 
for  past  investments  of  capital.  The  profits  on  capital  also,  accord- 
ing to  him,  are  simply  a  return  on  past  labor,  and  relatively  to  wages, 
a  diminishing  return.  For  it  is  a  peculiarity  of  labor  stored  up  in 
those  products  which  we  call  capital,  that  it  continually  diminishes 
in  value  as  compared  with  present  labor.  In  other  words,  wages 
are  continually  gaining  relatively  as  compared  with  the  profits  of 
capital.  Capital  may  gain  absolutely  on  account  of  the  increase 
in  the  amount  of  capital.  Wages  gain  both  absolutely  and  rela- 
tively. Value  gives  us  the  ratio  of  exchange  between  services. 
Economic  gain  is  in  proportion  to  economic  service  except  that  labor 
is  progressively  a  gainer  on  account  of  the  fact  that  man's  present 
services  (as  seen  in  labor)  increase  in  value  as  compared  with  man's 
past  services  as  accumulated  in  capital. 

As  Bastiat  denied  the  existence  of  pure  economic  rent  in  the 
Ricardian  sense,  he  also  denied  the  Malthusian  theory  of  popula- 
tion, holding  that  no  proof  could  be  adduced  of  a  tendency  of  popu- 
lation to  press  upon  the  means  of  subsistence.  The  evils  that  we 
experience  come,  according  to  Bastiat,  from  man's  interference 
with  natural  harmonies.  Nature  works  things  out  well,  and  this 
is  the  best  of  possible  worlds  if  we  could  only  let  nature  have  her 
way. 

Henry  C.  Carey,  the  American  contemporary  of  Bastiat,  held 
similar  doctrines,  and  was  apparently  the  more  original  man.  If 
either  one  borrowed  from  the  other,  it  must  have  been  Bastiat. 
Probably  neither  one  was  guilty  of  any  conscious  plagiarism. 

The  writings  of  the  optimists  had  a  considerable  influence  for  a 
time  in  Germany,  where  they  were  developed  and  applied  with 
uncompromising  logic  by  men  like  Prince-Smith,  Faucher,  and  a 
considerable  number  of  others  who  were  influential  in  the  press 
and  practical  affairs  rather  than  in  academic  life.  In  the  United 
States  these  writings  have  had  a  great  deal  of  influence  upon  a  num- 
ber of  early  writers,  among  whom  we  may  mention  especially  the  late 
Arthur  Latham  Perry,  long  professor  in  Williams  College,  and 
Edward  Atkinson,  a  well-known  statistician  and  writer  of  Boston. 

Early  American  Economists.  —  The  reaction  against  the  Eng 
lish  economists,  it  is  interesting  to  note,  began  earlier  in  the  United 
States  than  in  England  or  Germany.  In  the  early  part  of  the  nine- 
teenth century,  emphatic  dissent  from  the  English  doctrines  was 
voiced  by  a  group  of  publicists,  among  whom  may  be  mentioned 


APPENDIX  751 

Alexander  Hamilton,  Daniel  Raymond,  Matthew  Carey,  Hezekiah 
Niles,  and  Frederick  List.  Hamilton's  work  and  views  are  well 
known ;  Niles  and  Matthew  Carey  were  pamphleteers  of  consider- 
able note  in  the  first  third  of  the  nineteenth  century;  and  List, 
who,  in  the  view  of  some  authorities,  planted  the  seeds  of  the  Ger- 
man historical  school,  unquestionably  obtained  his  distinctive  na- 
tionalistic views  about  political  economy  in  the  United  States,  and 
first  formulated  them  in  his  Outlines  of  American  Political  Economy, 
published  in  1827.1 

Daniel  Raymond,  however,  of  all  the  American  writers  noted, 
is  the  least  known,  and  yet  the  author  of  the  first  American  treatise 
on  political  economy  in  which  a  distinctively  American  system  of 
economic  thought  is  suggested.  Raymond's  first  book,  Thoughts 
on  Political  Economy,  appeared  in  1820;  a  second  edition,  under 
the  title  Elements  f  Political  Economy,  appeared  in  1823,  and  the 
latter  was  reprinted  with  slight  changes  in  1836  and  1840.  The 
essence  of  Raymond's  system  is  found  in  his  conception  of  wealth. 
Wealth,  he  maintained,  is  not  an  aggregate  of  exchange  values 
but  the  opportunity  to  acquire  the  material  comforts  of  life  by 
labor.  The  English  political  economy,  in  Raymond's  view,  was 
a  study  of  private  as  opposed  to  political  or  national  economy. 
Raymond  emphasized  the  distinction  between  individual  and 
social  wealth,  and  maintained  that  the  laws  of  wealth  laid  down 
by  Adam  Smith  were  untrue  of  a  nation  conceived  as  a  unit.  The 
interests  of  particular  individuals,  or  particular  classes,  he  argued, 
do  not  always  coincide  with  the  interests  of  the  nation  as  a  whole, 
and  the  latter,  he  concluded,  will  be  best  advanced  by  developing 
all  the  national  powers  to  their  widest  possible  extent.  He  was 
thus  a  warm  advocate  of  protection  as  opposed  to  laissez-faire. 

Raymond's  views  had  so  impressed  Matthew  Carey  that  he  of- 
fered to  support  a  chair  of  political  economy  at  the  University  of 
Maryland  if  the  University  would  permit  Raymond  to  fill  it.  Mat- 
thew Carey's  son,  Henry  C.  Carey  (1793-1879),  by  far  the  most 
influential  of  the  early  American  economists,  was  in  like  manner 
probably  influenced  by  the  teachings  of  Raymond.  Carey  was 
not  only  an  earnest  champion  of  protection,  but  an  indefatigable 
critic  of  classical  economic  doctrines.  He  denied  the  truth  of 
the  Malthusian  principle  and  the  law  of  diminishing  returns;  ob- 
jected to  the  Ricardian  theory  of  rent ;  and  maintained  that  the 
value  of  a  commodity  depends  upon  the  cost  of  reproduction  rather 
than  the  cost  of  production,  as  was,  he  thought,  laid  down  in  the  classi- 
cal theory  of  value.  Carey  entertained  a  concept  of  wealth  very 
similar  to  that  of  Raymond,  and  in  some  parts  of  his  work  adopted 
methods  of  investigation  which  brought  him  in  close  touch  with 
the  sociologists  and  the  German  historical  economists.  The  key- 
stone of  his  economic  system  is  the  doctrine  of  association.     The 

1  List  returned  to  Germany  and  was  there  a  forceful  writer  and  agitator  fur 
German  unity,  and  is  identified  rather  with  the  history  of  economic  thought  of 
Germany  than  with  that  of  the  United  States. 


752  OUTLINES   OF  ECONOMICS 

increasing  mastery  of  man  over  nature,  or  the  increase  of  wealth, 
Carey  held  to  be  dependent  upon  the  increasing  efficiency  resulting 
from  a  compact,  homogeneous  population,  in  which  agriculture 
and  manufacture  are  conducted  side  by  side,  in  which  the  home- 
market  idea  is  carried  out  in  the  most  complete  way,  and  in  which, 
to  be  brief,  the  association  of  industrial  and  social  units  is  most 
intense  and  intimate.  It  can  be  readily  understood  why  the  eco- 
nomic philosophy  of  Carey  Was  so  inimical  to  free  trade  at  every 
point. 

The  Austrian  School.  —  The  protests  against  the  classical  econo- 
mists which  we  have  been  considering  were  directed  largely  against 
the  narrow  scope  and  deductive  methods  of  the  classical  school. 
The  Austrian  economists  represent  a  reaction  not  against  their 
methods,  but  against  the  conclusions,  and  particularly  against  the 
theory  of  value  of  the  classical  school.  The  great  contribution  of 
the  Austrian  school  is  the  marginal  utility  theory  of  value,  which 
has  been  most  assiduously  applied  in  economic  analysis  by  a  group 
of  Austrian  economists,  among  whom  may  be  specially  mentioned 
Menger,  Wieser,  Sax,  and  Bohm-Bawerk.  But  the  marginal  utility 
theory  of  value  was  advanced  almost  simultaneously,  about  187 1, 
by  the  English  economist  Jevons,  the  Austrian  economist  Menger, 
and  the  French  economist  Walras.1 

The  Austrians  have  been  a  leading  force  in  producing  what  is 
not  inaptly  termed  a  renaissance  in  theory,  although,  as  stated, 
they  indorsed  the  deductive  and  abstract  methods  of  the  classical 
economists.  The  classical  theory  put  the  emphasis  upon  supply 
or  the  conditions  of  supply,  maintained  that  cost  of  production 
determines  value,  and  found  the  ultimate  measure  and  explanation 
of  value  in  the  pain  and  sacrifice  of  labor.  The  Austrians  main- 
tain that  utility,  the  pleasure  or  satisfaction  derived  from  con- 
sumption, is  the  ultimate  cause  and  measure  of  value ;  they  empha- 
size demand  as  the  English  economists  emphasized  supply;  and 
hold  that  value  determines  cost  of  production  and  not  the  cost 
of  production,  value.  Capital,  they  conclude,  receives  its  value 
from  the  finished  product  instead  of  giving  value  to  that  product. 
The  work  of  this  school  has  tended  to  put  the  consumer  in  the  place 
primarily  occupied  by  the  capitalist  as  the  center  of  discussion  in 
economic  theory.  The  work  of  the  Austrians  has  had  a  profound 
influence  upon  economic  writing  in  the  United  States. 

Present  Condition  of  Economic  Thought.  —  The  net  effect  of  all 
these  protests  against  the  classical  English  economists  has  been 
to  introduce  a  welcome  catholicity  into  the  methods  of  economic 
investigation.  The  historical  school  emphasized  the  evolutionary 
standpoint  and  the  necessity  of  minute  investigation  of  the  facts 
of  industrial  life,  while  the  work  of  the  Austrians  operated  to  strengthen 
and  explain  the  necessary  place  of  deduction  in  economic  analysis. 

1  In  reality  the  marginal  utility  theory  had  been  explained  many  years  before 
this  by  a  number  of  obscure  writers  whose  ideas,  however,  never  affected  the  main 
current  of  economic  thought. 


APPENDIX  753 

Today  the  ordinary  economist  employs  either  method,  or  both,  as 
the  subject-matter  demands,  and  the  controversy  about  methods 
has  become  a  thing  of  the  past.  With  respect  to  the  theory  of  value, 
neither  supply  nor  demand,  neither  cost  nor  utility,  neither  the  capi- 
talist nor  the  consumer,  is  now  said  to  exert  a  predominating  influ- 
ence in  the  determination  of  values.  The  Austrian  school,  it  is  now 
understood,  supplied  a  needed  corrective  without  revolutionizing 
the  earlier  theory  of  value.  The  Austrians  themselves  are  seen  to 
have  been  guilty  of  laying  exaggerated  emphasis  upon  the  consumer's 
influence  upon  value  and  price,  and  there  is  reason  to  believe  that 
their  analysis  is  based  in  some  degree  upon  a  faulty  psychology. 

So,  similarly,  with  respect  to  the  scope  of  economics.  The  at- 
tempt of  the  classical  economists  to  isolate  an  "  economic  man  " 
ruled  entirely  by  an  enlightened  self-interest  and  unaffected  by 
political,  ethical,  and  humanitarian  impulses,  is  recognized  to  have 
been  a  mistake.  But  economics  has  never  given  itself  to  a  com- 
plete study  of  politics  or  ethics.  It  considers  ethical  and  political 
phenomena  when  these  cannot  be  dissociated  from  economic  phe- 
nomena, but  insists,  nevertheless,  upon  the  separation  of  economics 
from  ethics,  politics,  and  sociology.  We  recognize  that  these  fields 
are  not  wholly  or  clearly  differentiated,  but  we  recognize  just  as 
clearly  that  a  division  of  labor  is  necessary  if  accurate  results  are  to 
be  achieved.  Furthermore,  this  division  of  labor  is  showing  itself 
progressively  within  the  limits  of  economics  itself,  as  it  has  shown 
itself  in  all  growing  sciences.  Indeed,  the  present  condition  of  eco- 
nomic thought  was  so  accurately  predicted  by  W.  S.  Jevons,  in  1876, 
that  his  words  —  written  in  the  midst  of  the  controversy  among  the 
adherents  of  the  deductive,  historical,  mathematical,  and  sociological 
methods  of  investigation  —  may  well  be  employed  to  picture  the 
condition  of  the  science  of  economics  as  it  exists  today : 

"  As  I  have  previously  explained,  the  present  chaotic  state  of 
economics  arises  from  the  confusing  together  of  several  branches 
of  knowledge.  Subdivision  is  the  remedy.  We  must  distinguish 
the  empirical  element  from  the  abstract  theory,  from  the  applied 
theory,  and  from  the  more  detailed  art  of  finance  and  administration. 
Thus  will  arise  various  sciences,  such  as  commercial  statistics,  the 
mathematical  theory  of  economics,  systematic  and  descriptive 
economics,  economic  sociology,  and  fiscal  science.  There  may  even 
be  a  kind  of  cross  subdivision  of  the  sciences ;  that  is  to  say,  there 
will  be  division  into  branches  as  regards  the  subject,  and  division 
according  to  the  manner  of  treating  the  branch  of  the  subject.  The 
manner  may  be  theoretical,  empirical,  historical,  or  practical ;  the 
subject  may  be  capital  and  labor,  currency,  banking,  taxation,  land 
tenure,  etc.,  —  not  to  speak  of  the  more  fundamental  division  of  the 
science  as  it  treats  of  consumption,  production,  exchange,  and  dis- 
tribution of  wealth.  In  fact,  the  whole  subject  is  so  extensive, 
intricate,  and  diverse,  that  it  is  absurd  to  suppose  it  can  be  treated  in 
any  single  book,  or  in  any  single  manner."  x 

1  Jevons,  Theory  of  Political  Economy,  3d  ed.,  pp.  xv,  xvi. 
3C 


APPENDIX  B 

SUGGESTIONS   FOR  STUDENTS  AND  TEACHERS 

Some  teachers  of  economics  rely  chiefly  upon  classroom  discussions  of 
assignments  in  a  textbook,  supplemented,  possibly,  by  certain  other 
reading  requirements.  Others  make  large  use'  of  lectures  and  of  prob- 
lems and  brief  reports  assigned  in  connection  with  particular  subjects 
discussed  in  the  class.  Some  require  the  student  to  write  one  or  more 
longer  essays  or  themes  on  specific  topics.  In  this  book  specific  refer- 
ences, questions,  and  problems  have  been  appended  to  each  chapter. 
The  aim  has  been  to  list  only  books  and  papers  that  have  value  in  them- 
selves and  that  have  a  direct  bearing  upon  the  subject  matter  of  the 
respective  chapters.  References  to  parallel  discussions  in  other  elemen- 
tary textbooks  have  for  the  most  part  been  avoided,  the  aim  being  to 
enable  the  student  to  extend  his  inquiries  by  reading  more  advanced  and 
comprehensive  treatments  of  particular  problems. 

There  is  no  one  "  best  way  "  of  teaching  economics,  for  the  methods 
used  must  depend  very  largely  upon  the  size  of  the  classes  and  the 
maturity  of  the  students.  It  has  been  the  experience  of  the  writers, 
however,  that  whatever  the  relative  degree  of  emphasis  put  upon 
lectures,  classroom  discussions,  and  assigned  problem  work  of  different 
sorts,  mastery  by  the  student  of  one  book  on  general  economics,  or  at 
least  of  so  much  of  it  as  treats  of  fundamental  economic  principles,  is 
an  essential  part  of  every  introductory  course  in  the  subject.  When 
pressed  for  time,  the  teacher  using  this  book  may  find  it  desirable  to 
omit  all  of  it  save  Book  II,  "  Principles  and  Problems."  When  more 
time  is  available,  it  may  be  deemed  wise  to  include  discussions  of  certain 
subjects  not  treated  in  this  volume.  "  The  economic  problems  of  munic- 
ipalities," "the  elements  of  statistical  method,"  "  the  problems  of  poor 
relief,"  "  the  general  principles  of  market  organization,"  are  a  few  among 
many  possible  supplementary  topics. 

Valuable  suggestions  on  the  teaching  of  elementary  economics  will  be 
found  in  various  papers  and  discussions  printed  in  the  Journal  of  Political 
Economy,  Vols,  xvii-xxii  (i 909-1 914).  Some  help  may  also  be  gained 
from  papers  by  C.  J.  Bullock  (Education,  Vol.  xi) ;  F.  R.  Clow  (Economic 
Studies,  Vol.  iv) ;  R.  F.  Hoxie  (Journal  of  Political  Economy,  Vol.  ix) ; 
H.  R.  Mussey  (Educational  Review,  Vol.  xi) ;  and  H.  W.  ThursUe 
(School  Review,  Vol.  iv). 

754 


APPENDIX  755 

The  problem  of  making  an  adequate  amount  of  supplementary  reading 
available  to  students  in  large  classes  has  been  made  easier  to  solve  by  the 
publication  of  volumes  of  excerpts,  designed  for  this  particular  use. 
(W.  H.  Hamilton,  Current  Economic  Problems;  L.  C.  Marshall, 
C  W.  Wright,  and  J.  A.  Field,  Materials  for  the  Study  of  Elementary 
Economics ;  C.  J.  Bullock,  Selected  Readings  in  Economics;  F.  A.  Fetter, 
Source  Book  in  Economics.)  Similar  volumes  have  been  made  up  of 
material  on  special  economic  problems.  References  to  many  of  these 
will  be  found  among  the  reading  lists  appended  to  the  different  chapters 
in  this  book. 

General  Works  on  Economics.  —  Other  American  textbooks  on 
economics,  cf  college  grade,  are:  C.  J.  Bullock,  Introduction  to  the  Study 
of  Economics ;  H.  J.  Davenport,  Outlines  of  Economic  Theory;  F.  A.  Fet- 
ter, Principles  of  Economics ;  Irving  Fisher,  Elementary  Principles  of 
Economics;  H.  R.  Seager,  Introduction  to  Economics ;  and  E.  R.  A. 
Seligman,  Principles  of  Economics.  Larger  in  scope  or  more  detailed  in 
their  treatment  of  the  general  principles  of  economics  are  H.  J.  Daven- 
port, Economics  of  Enterprise;  F.  A.  Fetter,  Economics  (2  vols.) ;  A.  T. 
Hadley,  Economics ;  F.  W.  Taussig,  Principles  of  Economics  (2  vols.). 
F.  A.  Walker's  Political  Economy  ("  advanced  course  "),  although  pre- 
senting a  somewhat  antiquated  view  of  economic  principles,  will  be 
found  still  to  possess  much  interest  for  the  reader. 

Among  English  books,  Alfred  Marshall's  Principles  of  Economics 
occupies  a  peculiarly  authoritative  position.  It  is  characterized  by  an 
unusually  intimate  grasp  of  the  facts  of  modern  economic  life  and  by  a 
rare  degree  of  ability  in  critical  analysis.  It  attempts  to  reconcile  many 
of  the  modern  developments  in  economic  analysis  with  the  fundamental 
tenets  of  the  political  economy  of  David  Ricardo  and  John  Stuart  Mill. 
Critics  differ  with  respect  to  the  degree  of  success  with  which  Marshall 
has  accomplished  this  reconciliation.  Marshall's  Principles  is  difficult 
for  any  but  the  mature  student,  and  his  own  attempt  at  an  abridgement, 
his  Economics  of  Industry,  is  distinctly  inferior  to  the  larger  work.  Two 
excellent  books  that  are  based  in  large  measure  on  Marshall's  Principles 
are  S.  J.  Chapman,  Outlines  of  Political  Economy,  and  A.  W.  Flux, 
Economic  Principles.  The  comprehensive  English  work  of  J.  S.  Nichol- 
son (Principles  of  Political  Economy,  3  vols.)  is  even  more  conservative  in 
matters  of  economic  theory  than  is  Marshall's.  Edwin  Cannan's 
Wealth  is  a  small  manual  with  an  original  and  suggestive  point  of  view. 
Distinctly  the  most  readable  and  in  many  respects  one  of  the  best  recent 
English  works  is  P.  H.  Wicksteed's  The  Common  Sense  of  Political 
Economy. 

Special  mention  can  be  made  of  only  a  few  of  the  more  important 
German  and  Austrian  works  on  general  economics.  Adolf  Wagner's 
Grundlcgung  der  politischen  Oekonomie  (2  vols.)  is  characterized  by  great 


756  OUTLINES   OF   ECONOMICS 

erudition  and  by  systematic  and  painstaking  classifications  and  defini- 
tions. It  is  of  particular  interest  to  American  students  on  account  of  its 
distinctive  point  of  view,  and  especially  its  emphasis  upon  the  general 
ethical  and  political  aspects  of  economic  problems.  The  Allgemein? 
V olkswirtschaftslehre  of  Gustav  Schmoller  (2  vols.)  is  characterized  by 
the  consistent  use  of  the  historical  method,  and  by  the  extent  to  which 
psychology  and  ethnology  as  well  as  history  are  drawn  upon  to  explain 
modern  economic  institutions.  Wilhelm  Lexis's  Allgemeine  Volks- 
unrlschaftslehre  is  a  smaller  work,  embodying  a  better  exposition  of 
fundamental  economic  principles  than  is  found  in  most  German  works, 
and  distinguished  by  a  large  measure  of  originality.  The  Allgemeine 
V olkswirtschaftslehre  of  Eugen  von  Phillipovich  (2  vols.)  contains  a  more 
systematic  presentation  of  general  economics  than  does  any  other  work  in 
the  German  language.  It  is  distinctly  catholic,  or  perhaps,  eclectic, 
in  its  general  theories. 

The  Traite  theorique  el  pratique  d'economie  politique  (4  vols.)  of  Paul 
Leroy-Beaulieu  may  be  taken  as  the  best  example  of  a  rather  dogmatic 
type  of  laissez-faire  economics  that  still  commands  a  large  and  influential 
following  in  France.  Representative  of  a  newer  school  of  thought,  more 
hospitable  to  various  projects  for  constructive  economic  betterment,  is 
the  work  of  Charles  Gide,  whose  two  books  on  general  economics  are 
available  in  English  translation  (Political  Economy  and  Principles  of 
Political  Economy).  The  best  modern  French  work  is,  perhaps,  Adolphe 
Landry's  Manuel  d'economique. 

In  other  European  countries,  especially  in  Italy,  Holland,  and  the 
Scandinavian  countries,  there  has  been  much  economic  writing  of  a  high 
order.  Attention  may  be  called  to  the  English  translation  of  the  excel- 
lent Dutch  work  of  N.  G.  Pierson,  Principles  of  Economics  (2  vols.),  and 
to  the  French  translation  (Manuel  d'economie  politique)  of  a  book  (in 
Italian)  by  Vilfredo  Pareto,  which  is  possibly  the  most  noteworthy  of 
various  modern  works  in  which  mathematical  methods  are  used  in 
economic  analysis. 

Encyclopedias.  —  The  most  comprehensive  encyclopedia  of  economics 
is  the  great  Handwbrterbuch  der  Staatswissenschaften  (3d  ed.,  7  vols.), 
edited  by  Conrad  and  others.  A  smaller,  but  useful,  German  reference 
work  is  the  Worterbuch  der  V olkswirtschaft  (3d.  ed.,  2  vols.),  edited  by 
Elster.  In  French,  the  Nouveau  dictionnaire  d'economie  politique  (2  vols., 
with  supplements),  edited  by  Say  and  Chailley,  is  already  somewhat 
antiquated  and  represents  a  rather  narrow  point  of  view.  For  special 
fields  there  are  the  Dictionnaire  des  finances  (2  vols.),  edited  by  Say  and 
Foyot,  and  the  Dictionnaire  du  commerce,  de  I'industrie,  et  de  la  banque 
(2  vols.),  edited  by  Guyot  and  Raffalovich.  The  English  Dictionary  of 
Political  Economy  (3  vols.),  edited  by  Palgrave,  is  a  standard  reference 
work.     There  is  no  American  dictionary  or  encyclopedia  covering  the 


APPENDIX  757 

whole  field  of  economics.  The  Encyclopedia  of  Social  Reform,  edited  by 
Bliss,  is  useful  in  its  special  field.  Although  published  in  the  early 
eighties,  some  of  the  articles  in  Lalor's  Cyrlopadia  of  Political  Science, 
Political  Economy,  and  United  States  History  (3  vols.)  remain  of  value. 
The  newer  Cyclopedia  of  A  merican  Government,  edited  by  McLaughlin  and 
Hart,  may  be  consulted  on  topics  in  public  finance  and  related  fields. 

Periodicals.  —  Many  of  the  most  important  contributions  to  eco- 
nomics appear  in  special  periodicals  devoted  to  the  subject.  In  the 
United  States  there  are  the  Quarterly  Journal  of  Economics,  the  Journal 
of  Political  Economy  (monthly),  the  Political  Science  Quarterly ',  and  the 
American  Economic  Review  (the  organ  of  the  American  Economic  Asso- 
ciation, quarterly).  The  Annals  of  the  American  Academy  of  Political 
and  Social  Science  (monthly),  the  American  Political  Science  Review 
(quarterly),  and  the  American  Journal  of  Sociology  (bi-monthly), 
frequently  publish  papers  that  are  of  importance  for  the  student  of 
economics.  Limited  to  more  specialized  fields  are  the  Quarterly  Publica- 
tions of  the  American  Statistical  Association,  the  American  Labor  Legis- 
lation Review,  the  Bulletin  of  the  National  Tax  Association  (monthly),  and 
the  Survey  (weekly,  covering  the  field  of  charities  and  other  organized 
movements  for  social  betterment). 

In  England  the  principal  economic  periodicals  are  the  Economic 
Journal  (the  quarterly  organ  of  the  Royal  Economic  Society),  the 
Journal  of  the  Royal  Statistical  Society  (monthly),  and  the  Economic 
Review  (quarterly,  largely  devoted  to  the  ethical  aspects  of  economic 
problems).  The  economic  journals  of  the  various  countries  of  conti- 
nental Europe,  although  of  great  value  to  the  specialist,  are  too  numerous 
to  mention  here. 

The  "  trade  journals  "  of  different  special  industries  and  in  the  fields 
of  banking  and  insurance  are  often  useful  to  the  special  students  in  these 
fields.  In  particular  the  periodicals  dealing  with  the  general  conditions 
of  business  and  the  money  market  are  often  indispensable.  The  Com- 
mercial and  Financial  Chronicle  of  New  York  (weekly)  may  be  specially 
mentioned  on  account  of  the  completeness  and  accuracy  of  its  statistics 
of  money  market  conditions.  For  London  the  Economist  and  the  Statist 
occupy  a  similar  position.  The  Annual  Financial  Review  contains  con- 
venient compilations  of  the  more  important  statistics  that  have  appeared 
in  the  Commercial  and  Financial  Chronicle  during  the  preceding  year.  A 
useful  annual  survey  of  international  financial  conditions  is  given  by 
Raffalovich's  Le  marche"  financier  (Paris).  Such  annuals  as  the  States- 
man's Year  Book  (London),  Whitaker's  Almanac  (London),  and  the 
World  Almanac  (New  York),  are  often  useful  for  reference  purposes. 
The  American  Year  Book  contains,  among  other  things,  an  excellent 
annual  review  of  important  economic  legislation. 

Reference  to  the  enormous  output  of  articles  on  economic  subjects  in 


758  OUTLINES  OF  ECONOMICS 

periodicals  of  a  more  general  or  popular  type  is  now  easy  by  using  the 
"  cumulative  indexes  "  and  "  readers'  guides  "  that  will  be  found  in  most 
colleges  and  public  libraries.  These  articles  are,  of  course,  of  very  uneven 
quality  and  must  be  used  discriminatingly.  Most  of  the  more  important 
current  articles  on  economic  topics  are  listed,  with  many  brief  abstracts 
or  appraisals,  in  the  successive  numbers  of  the  American  Economic 
Review. 

Books  in  Special  Fields.  —  The  references  given  in  connection  with  the 
different  chapters  in  this  volume  are  sufficient  to  enable  one  to  make  a 
fairly  thorough  study  of  the  different  subjects  treated  in  these  chapters. 
Many  of  the  books  referred  to  contain  more  elaborate  bibliographies  on 
their  special  subjects.  The  student  should,  of  course,  be  familiar  with 
the  use  of  the  card  catalogue  of  a  modern  library.  In  using  such  a  cata- 
logue it  should  be  remembered  that  the  library  classification  of  books  by 
subjects  is  very  rarely  entirely  satisfactory,  so  that  one  should  exercise 
one's  ingenuity  in  searching  under  different  subjects.  The  Library  of 
Congress  has  printed  in  pamphlet  form  lists  of  books  and  articles  on 
various  practical  economic  problems,  and  is  often  able  to  furnish,  at  a 
small  price,  shorter  typewritten  lists  of  references  on  other  subjects. 
Short  annotated  bibliographies  are  issued  by  different  state  legislative 
libraries  and  municipal  reference  libraries.  The  bibliographies  in  the 
various  economic  encyclopedias,  especially  the  Handworterbuch  der 
Staalswissenschaften,  will  often  be  found  helpful.  A  very  complete  list  of 
new  books  in  various  fields  of  economics  is  published  quarterly  in  the 
American  Economic  Review. 

Government  Publications.  —  The  student  should  early  acquire  some 
familiarity  with  the  use  of  government  documents  as  first-hand  sources 
of  information.  Aside  from  statutes  and  the  proceedings  of  legislative 
bodies  these  publications  include  :  (i)  annual  reports  of  different  admin- 
istrative departments  and  bureaus  ;  (2)  reports  of  special  investigations 
made  by  the  permanent  bureaus  or  by  special  commissions ;  (3)  records 
of  the  hearings  before  legislative  committees  of  inquiry.  A  record  of  the 
enormous  output  of  the  publications  of  the  federal  government  is  con- 
tained in  the  Monthly  Catalogue  of  Public  Documents,  published  by  the 
Superintendent  of  Documents,  Washington.  This  has  an  annual  index, 
and  a  comprehensive  Document  Catalogue  is  also  published  for  each 
Congressional  period.  The  Check  List  of  Government  Documents  is 
convenient  to  use  in  locating  regular  or  routine  documents  published 
before  iqio.  The  Annotated  Tables  of  and  Consolidated  Index  to  the 
Congressional  Series  of  United  Stales  Public  Documents  may  also  be  used 
for  the  same  purpose.  Poore's  Descriptive  Catalogue  of  the  Government 
Publications  of  the  United  States,  1774-1SS1,  is  useful  in  locating  irregular 
or  obscure  publications  of  various  sorts.  In  nearly  every  congressional 
-district  there  is  a  public  or  college  library  which  is  an  official  depository 


APPENDIX  759 

for  federal  documents  and  has  a  nearly  complete  set  of  those  published 
in  recent  years.  Current  documents  may  sometimes  be  obtained  with- 
out charge  from  the  departments  or  bureaus  issuing  them  or  from  the 
Representative  or  Senator  from  one's  district  or  state.  They  can 
always  be  purchased  at  small  prices  from  the  Superintendent  of  Docu- 
ments. The  Superintendent  of  Documents  issues  small  printed  price 
lists  of  the  publications  in  different  special  fields. 

The  Library  of  Congress  publishes  a  Monthly  List  of  State  Documents. 
Bowker's  State  Publications  (three  parts)  give  a  fairly  complete  list  up  to 
about  1900,  and  a  full  index  to  the  economic  materials  in  state  documents 
is  being  published  by  the  Carnegie  Institution.  The  volumes  for  a 
number  of  the  larger  states  have  already  appeared.  Municipal  docu- 
ments are  often  published  in  an  unsystematic  way,  and  there  is  no 
general  index  or  list  of  either  current  or  past  municipal  publications. 
The  student  should  find  it  both  practicable  and  instructive,  however, 
to  become  acquainted  with  the  published  documents  of  the  city  in  which 
he  lives,  or  those  of  some  large  city  in  his  state. 

The  British  Parliamentary  Papers  contain  a  wealth  of  material  on  a 
wide  range  of  economic  topics.  Much  of  this  is  listed  in  P.  S.  King  & 
Son's  Catalogue  of  Parliamentary  Papers,  1801-iQOO  (with  Supplement, 
iqoi-iqio).  Lists  of  current  publications  are  published  by  several  Lon- 
don dealers.  The  more  important  ones  are  noted  in  the  English  eco- 
nomic journals,  and  (more  fully)  in  an  occasional  "  Blue  Book  Sup- 
plement "  to  the  New  Statesman,  a  London  weekly.  Among  the  gov- 
ernment publications  of  other  countries  we  can  mention  here  only  the 
valuable  statistical  year-books  published  by  many  nations  and  by  a 
number  of  important  cities.  The  student  will  find  the  statistical  annuals 
of  Australia  and  New  Zealand  especially  interesting  and  instructive. 


INDEX 


Activity,  desire  for,  as  an  economic 
motive,  104. 

Adams,  H.  C,  on  fiscal  aspects  of  the 
tariff,  717. 

Agriculture,  changes  in,  in  England,  41, 
50;  history  of,  in  United  States,  84; 
problems  of,  596. 

Agricultural  credit,  609. 

Agricultural  stage,  37. 

Aldrich,  N.  W.,  plan  for  banking  reform, 
306. 

Aldrich-Vreeland  Act,  305. 

Altruism,  as  an  economic  force,  103. 

American  Federation  of  Labor,  94,  444. 

American  people,  economic  characteris- 
tics of,  63. 

Amortization  of  taxes,  706. 

Anarchism,  638. 

Andrew,  A.  P.,  on  control  of  banking  re- 
serves by  Secretary  of  the  Treasury, 

354- 
Annual  product,  defined,  517. 
Anti-trust  laws,  235. 
Arbitration,  in  labor  disputes,  95,  457. 
Aristotle's  Politics,  741. 
Artificers,  statute  of,  43. 
Assumption  of  risk,  legal  doctrine  of,  487. 
Austrian  school,  752. 
Averages,  340. 

Balanced  revenue  system,  735. 

Balance  of  trade,  345;  meaning  of  a 
"favorable  balance,"  356;  in  the  com- 
merce of  the  United  States,  357. 

Bank  acceptances,  346  n. 

Bank  credit,  286. 

Bank  notes,  200,  291,  306,  309. 

Bank  of  England,  control  of  gold  reserves, 
302. 

Banking,  functions  of,  283.  See  Na- 
tional banking  system,  Federal  reserve 
system. 

Bargaining,  surplus  in,  181. 

Basing-point  system,  570. 

Bastiat,  Fr6d6ric,  750. 


Benefit  principle,  in  taxation,  698. 

Bentham,  Jeremy,  746. 

Bills  of  credit,  colonial  and  revolution- 
ary, 272. 

Bimetallism,  260;  in  the  United  States, 
264;  international,  263. 

Birth  rate,  in  United  States,  65. 

Blackstone,  definition  of  monopoly,  190  n. 

Bland-Allison  Act,  266. 

Blodgett,  J.  H.,  on  wages  of  farm  labor, 
607. 

Bonds,  corporation,  220;  government, 
as  security  for  bank  notes,  300.  See 
Public  debts. 

Boycotts,  legality  of,  475. 

Brassage,  258. 

Brown,  E.  F.,  on  factory  inspection  in 
the  United  States,  485. 

Budgets,  French,  old  and  modern  con- 
trasted, 657 ;  American,  662. 

Bullock,  C.  J.,  on  foreign  trade  balances 
of  the  United  States,  357. 

Business  organization,  forms  of,  214. 

Business  taxes,  733. 

Business  unit,  in  accounting,  213;  in 
law,  214.    See  Large-scale  production. 

Call  loans,  289,  295. 

Canadian  Industrial  Disputes  Act,  459. 

Canon  law,  economic  ideas  in,  743. 

Carey,  H.  C,  750,  751. 

Carver,  T.  N.,  on  the  effects  of  the  ma- 
chine system  upon  the  workers,  127. 

Capital,  as  a  factor  in  production,  121; 
distinguished  from  capital  value,  no; 
distinguished  from  consumption  goods, 
512;  distinguished  from  land,  507; 
social  and  individual,  in;  free  and 
specialized,  506;  investment  in,  499, 
513;  replacement  of,  501;  effects  of 
varying  degrees  of  durability  of,  502; 
price  of,  how  determined,  505 ;  pro- 
ductivity of,  relation  to  interest.  495; 
relation  to  advances  of  wages,  51-' ;  in 
business  usage,  21Q. 


761 


702 


INDEX 


Capitalization,  corporation,  219,  221, 
225  ;  of  rent,  418. 

Central  banks,  304,  307. 

Central  reserve  system,  292. 

Charters,  corporation,  217. 

Child  labor  laws,  56,  476. 

Christianity,  influence  on  economic 
thought,  742. 

Christian  socialism,  630. 

Cities,  growth  of,  in  United  States,  66. 

Class  price,  204. 

Classical  school,  746. 

Clayton  Anti-trust  Act,  241 ;  in  relation 
to  labor  organizations,  473. 

Clearing  houses,  283. 

Clearing-house  loan  certificates,  284  «., 
305. 

Closed-shop  policy,  448. 

Coinage,  249 ;  of  standard  money,  255 ; 
limited,  259. 

Coke,  definition  of  monopoly,  190  «. 

Collective  bargaining,  442,  446. 

Colonial  policy,  British,  80. 

Combination  Act,  British,  58. 

Combinations,  industrial,  230;  causes 
of,  232  ;  public  policy  toward,  243  ;  in 
other  countries,  245;   railway,  561. 

Commerce  Court,  574. 

Commons,  J.  R.  on  relation  of  monopo- 
lies to  the  distribution  of  wealth,  550. 

Comparative  costs,  law  of,  362 ;  relation 
to  doctrine  of  free  trade,  375. 

Competition,  described,  28;  failure  of, 
under  certain  conditions,  198;  relation 
to  maximum  satisfaction  of  wants,  538. 

Competitive  investment,  513. 

Commission  merchants,  620. 

Communism,  631. 

Compulsory  arbitration,  459. 

Comte,  Auguste,  749. 

Concentration  in  industry,  88.  See 
Large-scale  production. 

Concentration  of  wealth,  distinguished 
from  large-scale  production,  542; 
methods  of  measuring,  543  ;  possibility 
of  lessening,  551 ;  suggested  remedies, 
554- 

Conspiracy,  legal  status  of,  472. 

Constant  expenses,  relation  to  normal 
price,  171. 

Constitutional  limitations,  to  govern- 
ment regulation  of  industry,  96;  to 
railway  regulation,  184,  573;  to  taxa- 
tion, 710. 

Consumers'  surplus,  161. 


Consumption,  defined,  132 ;  statistics  of, 
144 ;   harmful,  144. 

Consumption  goods,  no. 

Contract,  as  an  economic  institution,  25 ; 
in  relation  to  distribution  of  wealth,. 
386. 

Contributory  negligence,  legal  doctrine 
of,  487. 

Cooperation,  as  an  economic  institution, 
30 ;  different  forms  of,  464 ;  in  market- 
ing, 465,  619 ;  cooperative  credit,  465, 
613. 

Copyrights,  23 ;  as  a  source  of  monopoly, 
i95- 

Corporations,  as  business  units,  216; 
charters  of,  217;  advantages  of,  228; 
growth  of,  87;  management  of,  226; 
social  aspects  of,  228;  lack  of  uni- 
,  formity  in  state  laws,  218 ;  federal  con- 
trol needed,  245;  taxation  of,  731. 
See  Capitalization,  Overcapitalization, 
Combinations. 

Corpus  juris  chills,  742. 

Cost  of  living,  statistics  of,  341,  548. 

Cost  of  production,  148.  See  Expenses 
of  production. 

Cotton  industry,  growth  of  in  early 
nineteenth  century,  82. 

Credit,  functions  of,  282  ;  personal  credit, 
285 ;  bank  credit,  286 ;  credit  trans- 
actions, 282. 

Crises,  analyzed,  333 ;  crisis  of  1873,  276 ; 
1892,  267  ;  1907,  305. 

Custom,  as  an  economic  institution,  31. 

Customs  duties,  fiscal  aspects  of,  713. 
See  Protection. 

Decreasing  expenses,  relation  to  normal 
price,  171. 

Deferred  payments,  standard  of,  337. 

Demand,  nature  of,  156;  demand  curve, 
158. 

Deposits,  bank,  283;  how  safeguarded, 
287. 

Dewing,  A.  S.,  on  inefficiency  of  indus- 
trial combinations,  235. 

Diminisliing  productivity,  law  of,  388; 
of  labor,  390 ;  of  capital  and  land,  392 ; 
actual  operation  of,  395 ;  social  aspects 
of,  401.     See  Marginal  productivity. 

Diminishing  returns,  law  of,  419. 

Diminishing  utility,  law  of,  133. 

Direct  appropriation,  stage  of,  34. 

Direct  taxes,  702,  710;  use  of,  by  federal 
government,  712. 


INDEX 


76* 


Discount,  bank,  287  n. ;  rates,  relation  of 
to  price  of  foreign  exchange  and  to 
international  gold  movements,  302, 
311,  346,  349,  351. 

Distribution  of  wealth,  as  a  general  eco- 
nomic problem,  384;  among  persons, 
542. 

Distributive  cooperation,  464. 

Distributive  justice,  627. 

Division  of  labor,  19;  effects  upon  the 
worker,  127;  relation  to  condition  of 
decreasing  expenses,  172. 

Documentary  bills,  346. 

Domestic  system,  40. 

Economics,    defined,    4;     distinguished 

from  economy,  13;    concepts  of,  103; 

relation  to  other  sciences,  1 1 ;  laws  of, 

7- 
Economic  classes,  21. 
Economic  goods,  defined,  106. 
Economic  society,  evolution  of,  33. 
Economic  stages,  33 ;    table  of,  45 ;    in 

American  history,  61. 
Economic    thought,     history    of,     741 ; 

present  condition  of,  752. 
Effort,  necessary  to  production,  106. 
Elasticity  of  demand,  159. 
Employers'  associations,  95,  454. 
Employers'  liability,  law  of,  56,  486,  588. 
Endowments,  584. 

Engel,  Ernst,  laws  of  expenditure,  145. 
Entrepreneur,  functions  of,  123;   as  risk 

taker,  537. 
Entrepreneur's  wage,  168,  526. 
Equation  of  exchange,  321. 
Esteem,  desire  for,  as  an  economic  motive, 

104. 
Ethics  and  politics,  relation  to  economics, 

15- 
Exchange,  19.     See  Division  of  labor. 
Exchange  value.     See  Value. 
Expenses  of  production,  148 ;   relation  to 

price,  167,  186. 
Express  trusts,  228  n. 

Fabian  socialism,  629. 

Factors  of  production,    119;    ultimate, 

522. 
Factory  acts,  in  United  States,  484. 
Factory    system,    in    England,    51;     m 

United  States,  82. 
Faculty  principle,  in  taxation,  698. 
Fair  competition,  29. 
Farming,  intensive  and  extensive,  600. 


Farms,  size  of,  in  United  States,  59*6; 
ownership  and  tenancy,  603 ;  indebted- 
ness, 609. 

Favoritism,  as  a  source  of  monopoly 
power,  191,  197. 

Federal  Farm  Loan  Board,  613. 

Federal  land  banks,  614. 

Federal  Reserve  Board,  307. 

Federal  reserve  system,  organization, 
307;  reserves,  308;  rediscounting, 
308;  note  issue,  310;  other  functions, 
310;  resources  and  liabilities  of,  in 
1916,  313. 

Federal  taxation,  710. 

Federal  Trade  Commission,  142. 

Fees,  as  source  of  public  revenue,  690. 

Fellow-servant  doctrine,  487. 

Fiat  money,  278. 

Final  consumption,  132. 

Finance  bills,  350. 

Fiscal  monopolies,  197,  682. 

Fisher,  Irving,  proposal  for  a  "stabilized 
dollar,"  342  ;  Statistical  verification  of 
the  equation  of  Exchange,  324  n. 

Fisk,  G.  M.,  on  early  restrictions  on  in- 
ternational trade,  358. 

Fixed  and  variable  expenses,  174;  rela- 
tion to  normal  price,  177 ;  in  railway 
operation,  569. 

Foreign  exchange,  345. 

Forest  lands,  674. 

Form  utility,  116. 

Fourteenth  Amendment,  184,  573. 

Freedom,  economic,  26 ;  relation  to  dis- 
tribution, 386;  of  contract,  472. 

Free  goods,  105,  401. 

Free  silver.     See  Bimetallism. 

Free  trade,  advantages  of,  374. 

Future  products,  alleged  present  con- 
sumption of,  142. 

Future  wants,  140. 

General  changes  in  prices,  relation  to 
quantity  of  money,  319;  mechanism 
of,  325 ;  effects  of  industrial  uses  of 
gold  upon,  327  ;  effects  of  expenses  of 
gold  production  upon,  328;  economic 
effects  of,  331 ;  relation  to  international 
gold  movements,  351;  index  numbers 
of,  337- 

General  property  tax,  726;  defects  of 
727  ;  reform  of,  729. 

General  welfare  monopolies,  195. 

George,  Henry.     See  Single  tax. 

Gilds,  39. 


764 


INDEX 


Godin  familistire,  466. 

Godwin,  William,  748. 

Gold,  as  monetary  standard,  255,  269; 
relation  of  industrial  uses  of,  to  prices, 
327 ;  relation  of  expenses  of  production 
to  prices,  328;  increase  in  production 
of,  329;  international  movement  of, 
350. 

Gold-exchange  standard,  269. 

Gold  points,  348. 

Goldenweiser,  E.  A.,  on  farmers'  incomes, 
607. 

Goods,  defined,  105. 

Good-will,  in  relation  to  profits,  535. 

Government  enterprise,  extension  of  in 
England  in  nineteenth  century,  58. 

Government  ownership,  of  railways,  571 ; 
of  other  industries,  682. 

Government  paper  money,  271. 

Greeks,  economic  ideas  of,  741. 

Greenbacks,   273;    economic  effects  of, 

275- 
Greenback  party,  278. 
Gresham's  law,  261. 
Group  rates,  570. 

Hadley,  A.  T.,  on  improvident  poor  re- 
lief, 552- 

Hamilton,  Alexander,  Report  on  the 
establishment  of  a  mint,  264  n. 

Handicraft  stage,  39. 

Hedging,  532  ».,  624. 

Hildebrand,  Bruno,  classification  of 
economic  stages,  44. 

Historical  school,  749. 

Holding  company,  231. 

Hours  of  labor,  statistics  of,  548. 

Hume,  David,  on  Elizabethan  monop- 
olies, 206. 

Hunter,  Robert,  on  distinction  between 
poverty  and  pauperism,  553. 

Immigration,     to    United    States,     68; 

changing  character  of,  70;    restriction 

of,  72. 
Imputed  interest,  495. 
Inclosures,  41,  50. 
Incomes,  estimates  of  distribution  of  in 

United  States,  544 ;  in  Prussia,  546. 
Income  taxes,  720. 
Increasing  expenses,  relation  to  normal 

price,  170. 
Indentured  servants,  in  United  States,  66. 
Independent  treasury  system,  297,  353. 
Index  numbers,  337. 


India,  monetary  system  of,  270  n. 

Indirect  taxes,  702,  713. 

Individual  entrepreneur,  as  business 
unit,  214. 

Individual  wealth,  contrasted  with  social 
wealth,  109. 

Industrial  combinations,  230;  causes  of, 
233 ;  legal  status,  235 ;  public  policy 
toward,  243;   in  other  countries,  245. 

Industrial  democracy,  463. 

Industrial  insurance,  585. 

Industrial  Revolution,  47 ;  evils  of  transi- 
tional period,  52;  in  America,  81. 

Inelastic  currency,  300. 

Inelastic  reserves,  301. 

Inheritance,  24;  effect  on  distribution, 
386;   taxation  of,  723. 

Instincts  and  habits,  in  economic  activity, 
105. 

Insurance,  nature  of,  577 ;  development 
of,  578;  forms  of  organization,  580. 
See  Life  insurance,  Social  insurance. 

Integration  of  industry,  88. 

Interest,  formerly  condemned,  493,  743 ; 
inadequate  explanations  of,  494 ;  how 
possible,  495 ;  why  necessary,  496  ; 
normal  interest,  511 ;  rate,  determined 
by  supply  and  demand  of  investment 
funds,  521 ;  on  farm  mortgage  loans, 
610.    See  Discount. 

Internal  improvements,  state  activity  in, 
93,  217. 

Internal  revenues,  717. 

International  gold  movements,  302,  311, 
348,  350.    See  Balance  of  trade. 

International  trade,  restrictions  of,  in 
former  times,  358 ;  modern  restrictions, 
360;  advantages  of,  361. 

Interstate  Commerce  Act,  573. 

Interstate  Commerce  Commission,  574. 

Inventions,  eighteenth  century,  49. 

Investment,  in  capital  goods,  499,  513; 
shifting  of,  502 ;  affected  by  durability 
of  capital  goods,  502 ;  competitive, 
513;   cumulative  nature  of,  518. 

Investment  funds,  sources  of,  523. 

Jaures,  Jean,  on  policies  of  socialism,  630. 
Jenks,  J.  W.,  investigation  of  monopoly 

prices,  206. 
Jevons,  W.  S.,  on  necessary  subdivision 

of  economic  science,  753. 
Joint  expenses,  relation  to  normal  price, 

179. 
Joint-stock  companies,  216  n. 


INDEX 


76; 


Kartells,  246. 

Kelley,   Florence,  on  child  labor  laws, 

478 ;  on  minimum  wage  laws,  480. 
Kemmerer,  E.  \V.,  statistical  verification 

of  the  equation  of  exchange,  324  «. 
King,  W.  I.,  estimates  of  distribution  of 

incomes  in   the   United   States,    545, 

645  n. 
Knights  of  Labor,  g4,  444. 
Kropotkin,  P.,  on  anarchism,  63g. 

Labor,  as  a  factor  in  production,  120. 
See  Wages. 

Labor  legislation,  471 ;  general  principles 
of,  488 ;   in  England,  56. 

Labor  organizations,  development  of,  in 
United  States,  93 ;  in  England,  57 ; 
types  of,  444;  economic  justification, 
445;  as  monopolies,  446 ;  methods  and 
policies,  447  ;  educational  and  fraternal 
activities,  45 1 ;  relation  to  industrial 
democracy,  468;  legal  status  of,  58, 
237,  472. 

Labor-saving  machinery,  effect  on  wages, 
430. 

Laissez-faire,  54,  745-748. 

Land,  as  a  factor  in  production,  119; 
services  of,  408;  distinguished  from 
capital,  507.  See  Rent,  Public  do- 
main. 

Land  nationalization.     See  Single  tax. 

Large-scale  production,  economies  of, 
relation  to  normal  price,  173 ;  not  a 
source  of  monopoly  power,  200. 

Lexis,  Wilhelm,  on  coinage  regulations, 
257- 

License  taxes,  733. 

Life  insurance,  581 ;  premium  plans,  582 ; 
reserve  and  surplus,  583 ;  industrial, 
585 ;  State,  585 ;  State  regulation  of, 
586;  for  workingmen,  593. 

Life  tables,  589. 

Limitation  of  output,  by  labor  organiza^ 
tions,  449;  by  monopolies,  201. 

List,  Friedrich,  751. 

Localization  of  industry,  128. 

Luxury,  143. 

Malthus,  T.  R.,  746 ;  law  of  population, 

434.  746. 
Manor,  English,  37. 
Manufactures,  growth  of,  in  the  United 

States,  86. 
Margin  of  consumption,  141. 
Margin  of  cultivation.     Sec  Rent. 


Marginal  productivity,  390;  of  labor 
390 ;  of  capital  and  land,  392  ;  general 
principles  of,  396 ;  relation  to  prices  of 
production  goods,  398 ;  lack  of  ethical 
significance,  403 ;  relation  to  profits, 
532.     See  Diminishing  productivity. 

Marginal  utility,  defined,  135 ;  illus- 
trated, 136. 

Markets,  defined,  154;  expansion  of,  53. 

Marketing  of  farm  products,  618. 

Marx,  Karl,  labor  theory  of  value,  186; 
other  doctrines,  629. 

Marxian  socialism,  629. 

Medium  of  exchange  and  measure  of 
value,  252. 

Mercantile  system,  42,  359,  744;  in 
America,  79. 

Mill,  J.  S.,  on  equilibrium  of  supply  and 
demand,  165. 

Minimum  wage  laws,  459,  480. 

Mint  ratio,  260. 

Mitchell,  W.  C,  statistics  of  prices  and 
wages  in  the  greenback  period,  277. 

Monetary  standard,  255.  See  Bimetal- 
lism. 

Money,  defined,  250,  251 ;  metallic,  249; 
varieties  used  in  the  United  States, 
254;  government  paper  money,  271; 
value  of,  317. 

Money  income,  387  ;  flow  of,  515. 

Money  market,  defined,  289 ;  controlling 
conditions,  289;  New  York,  293; 
London,  347. 

Monopolies,  Statute  of,  191 ;  Case  of, 
191 ;  classification  of,  193 ;  labor 
organizations  as,  446. 

Monopoly,  30;  defined,  190;  contrasted 
with  competition,  189;  distinguished 
from  differential  advantage  and  from 
large-scale  business,  193;  relation  to 
distribution  of  wealth,  207,  550; 
public  policy  with  respect  to,  208. 

Monopoly  price,  200 ;  relation  of  demand 
to,  203 ;  effect  of  taxation,  202 ; 
usually  high,  205. 

Mortgage  land  banks,  612. 

Motives  in  economic  activity,  103, 
538. 

Mun,  Thomas,  744. 

Munn  vs.  Illinois,  573. 

National  banking  system,  291 ;  reserves, 
292,308;  notes,  292,  300,  309;  defects 
of,  295 ;  steps  toward  reform  of,  304. 
See  Federal  reserve  system. 


766 


INDEX 


National  income,  denned,  114. 
National    Monetary    Commission,    306, 

316. 
National  wealth,  statistics  of,  112. 
Natural  laws,  8. 
Natural  monopolies,  197. 
Natural  resources,  of  United  States,  74. 
Navigation  Acts,  80. 
Negro  problem,  in  United  States,  66. 
New  York  money  market,  293 ;   relation 

to  speculation,  295. 
New  Zealand,  compulsory  arbitration  in, 

459- 
Non-reproducible  goods,  price  of,  182. 
Normal  interest,  511. 
Normal  price,  169. 

Occupational  distribution  of  the  Ameri- 
can people,  86. 

Old  age  pensions,  592. 

Open-market  operations  of  federal  reserve 
banks,  311. 

Opportunity  cost,  148. 

Optimists,  economic,  749. 

Overcapitalization,  221. 

Owen,  Robert,  628. 

Paper  money,  271. 

Par  of  exchange,  348. 

Partnerships,  215. 

Pastoral  stage,  36. 

Patents,  23 ;    as  a  source  of  monopoly, 

Personal  distribution  of  wealth,  542. 

Personal  property  tax,  726. 

Personal  qualities  as  goods,  107. 

Philippines,  monetary  system  of,  270  n. 

Physiocrats,  745. 

Place  utility,  116. 

Plato's  Republic,  741. 

Pollock  case,  711. 

Poll  taxes,  734. 

Pools,  231,  56r. 

Population,    growth    of    in    nineteenth 

century,  435;    growth  of,  in  United 

States,  64.     See  Malthus. 
Poverty,  causes  of,  549. 
Power,  desire  for,  as  an  economic  motive, 

104. 
Present  economic  system,  characteristics 

of,  17. 
Price,  defined,  152;   fixed  by  equilibrium 

of  supply  and  demand,    161;    normal 

price,   169;    monopoly  price,   200;    of 

production  goods,  398,  418,  505;    of 


public    services,     685.     See    General" 
changes  in  prices. 

Primitive  man,  economy  of,  35. 

Private  banks,  314. 

Private  property,  as  an  economic  insti- 
tution, 21 ;  relation  to  distribution,  386. 

Probabilities,  law  of,  578. 

Producers'  cooperation,  466. 

Producers'  surplus,  165. 

Production,  denned  117;  relation  to 
sacrifice,   146. 

Production  goods,  iro,  401;  prices  of, 
185,  398,  418,   505. 

Production  of  gold,  increase  in,  329. 

Productive  consumption,  132. 

Productive  organization  of  the  American, 
people,  129. 

Productivity,  meaning  of,  400,  497. 

Profits,  525;  pure  profits  distinguished 
from  entrepreneur's  wage,  526;  non- 
existent under  certain  conditions,  527 ; 
two  sources  of,  528;  relation  to  prin- 
ciple of  diminishing  productivity,  532  ; 
for  the  industry  and  for  the  establish- 
ment, 533  ;  relation  to  good-will,  535  ; 
relation  to  risk,  540;  often  associated 
with  other  forms  of  income,  538; 
relation  to  defense  of  the  competitive 
system,  538;   of  monopoly,  201. 

Profit  sharing,  461. 

Protection,  nationalistic  argument  for, 
368;  infant  industry  argument,  369, 
376;  military  argument,  370;  home 
market  argument,  371,  376;  as  a  de- 
fense against  dumping,  371 ;  wages  ar- 
gument, 373,  377  ;  "equalizing  costs  of 
production,"  373;  fiscal  aspects  of, 
378,  713;  Ethical  aspects  of,  379; 
relation  to  monopoly,  194,  380. 

Public  authority,  relation  of,  to  prices, 
183. 

Public  consumption  monopolies,  197,  682. 

Public  debts,  increase  of,  666 ;  relation  to 
public  works,  668 ;  relation  to  taxes, 
668;   wise  use  of,  610. 

Public  domain,  as  a  source  of  revenue, 
671.     See  Public  lands. 

Public  expenditures,  growth  of,  644 ; 
contrasted  with  private  expenditures, 
646 ;  relation  to  total  social  income, 
648 ;  extravagance,  economy,  and 
parsimony  in,  distinguished,  652 ; 
changing  objects  of,  654 ;  regularity 
of,  659;  classification  of,  660;  statis- 
tics of,  in  United  States,  662. 


INDEX 


767 


Public  finance,  643. 

Public  lands  of  the  United  States,  eco- 
nomic importance  of,  75  ;  development 
of  government's  policy,  76,  673 ; 
forest  lands,  674;    mineral  lands,  675. 

Public  monopolies,  194. 

Public  receipts  from  loans,  661 ;  from 
public  domain,  671;  from  public 
industries,  682 ;  from  fees,  690 ; 
from  special  assessments,  692 ;  from 
taxes,  694;  statistics  of,  for  the 
United    States,    695. 

Quality  of  goods,  government  regulation 

of  in  England,  55. 
Quantity  theory  of  prices,  324. 
Quasi-rent,  509. 
Quesnay,  745. 

Race  suicide,  65. 

Railway  rates,  movement  of,  563 ; 
general  level  of,  565;  relative,  567; 
distance,  as  a  factor  in,  570. 

Railways,  history  of,  in  United  States, 
91;  economic  importance  of,  558; 
competition  of,  91,  560;  pooling  and 
consolidation,  560 ;  valuation  of,  566 ; 
expenses  of,  apportionment,  568 ; 
government  ownership,  571;  govern- 
ment regulation,  573 ;  affected  by 
Sherman  Anti-trust  Act,  237. 

Raymond,  Daniel,  751. 

Rediscounting,  308. 

Religion  as  an  economic  factor,  104. 

Rent,  407 ;  under  uniformly  intensive 
use  of  land,  410;  under  actual  condi- 
tions, 413;  relation  of  different  uses 
of  land  to,  416;  the  specific  product 
of  land,  394,  416;  capitalization  of, 
418;  relation  to  social  progress,  419. 

Replacement  fund,  501. 

Reserve,  insurance,  583. 

Reserves,  bank,  288,  292,  301,  308. 

Retail  prices,  182. 

Ricardo,  David,  746. 

Risk,  107;  relation  to  profits,  536;  re- 
lation to  insurance,   577. 

Romans,  economic  ideas  of,  742. 

Roosevelt,  Theodore,  on  mineral  land 
policy,  676. 

Rowntree,  B.  S.,  on  causes  of  "primary" 
poverty,  551. 

Rubinow,  I.  M.,  on  recent  changes  in 
real  wages,  547. 

Rural  credit,  609. 


Saving,  and  the  formation  of  capital,  122, 
497,  502,  522. 

Savings  banks,  314. 

Scarcity,  _  necessary  condition  of  value, 
106,  156,  401 ;  of  raw  materials,  a 
source  of  monopoly  power,  197. 

Second  Bank  of  the  United  States, 
304  »• 

Secrecy,  as  a  source  of  monopoly  power, 
199. 

Sectionalism,  in  American  history,  62. 

Seigniorage,  255 ;  on  limited  coinage, 
259-  _ 

Self-maintenance,  as  an  economic  motive, 
103. 

Serra,  mercantilistic  writings  of,  744. 

Services,  as  economic  goods,  106. 

Shaw,  L.  M.,  control  of  gold  reserves  by, 
when  Secretary  of  the  Treasury,  353. 

Shays's  rebellion,  62. 

Sherman  Anti-trust  Act,  236. 

Sherman  Silver-purchase  Act,  266. 

Shifting  of  taxes,  on  monopolies,  202  ; 
general  theory  of,  703 ;  of  import 
duties,  714. 

Sickness  insurance,  591. 

Single  tax,  425,  679,  706;  impdt  unique, 
745- 

Size  of  business  unit,  increase  in,  88; 
statistics  of,  89.  See  Large-scale  pro- 
duction. 

Slater,  Samuel,  82. 

Slavery,  37 ;   in  the  United  States,  66. 

Small  Holdings  Act,  602. 

Smith,  Adam,  48,  53,  745 ;  on  wages  in 
different  employments,  441. 

Smith,  Constance,  on  operation  of  British 
Trade  Boards  Act,  483. 

Social  dividend,  517. 

Social  insurance,  57 ;  defined,  587  ; 
against  industrial  accidents,  487,  588; 
against  sickness,  591 ;  against  old  age, 
592 ;  against  unemployment,  592 ; 
objections  to,  593. 

Social  laws,  nature  of,  11. 

Social  monopolies,  195. 

Social  wealth,  contrasted  with  individual 
wealth,  109. 

Socialism,  defined,  627  ;  varieties  of,  628 ; 
an  extension  of  existing  institutions, 
632;  strength  of,  632;  weakness  of, 
634 ;  growth  of,  636 ;  position  in  eco- 
nomic thought,  748. 

Sociology,  13,  748. 

Special  assessments,  692. 


768 


INDEX 


Special  privilege  monopolies,  197. 

Specialization.    See  Division  of  labor. 

Specie  payments,  suspension  of,  273 ; 
resumption  of,  275. 

Specific  productivity.  See  Marginal  pro- 
ductivity. 

Speculation,  relation  to  New  York  money 
market,  295 ;  as  a  source  of  profits, 
534;  in  agricultural  produce,  622. 

Standard  of  deferred  payments,  336. 

Standard  of  life,  438. 

Standard  Oil  Co.  Case,  230. 

Standard  Oil  Trust,  230. 

State  activity,  present  scope  of,  17. 

State  banks,  before  Civil  War,  200 ;  pres- 
ent position,  313. 

State  insurance,  585. 

State  regulation  of  industry,  develop- 
ment of,  in  United  States,  96.  See 
Anti-trust  laws,  Labor  legislation, 
Railways. 

State  socialism,  631. 

State  and  local  taxation,  726. 

Steuart,  Sir  James,  744. 

Stock,  corporation,  220. 

Strikes,  452. 

Subjective  value,  137;  of  a  stock,  138; 
relation  to  exchange  value,  155. 

Subsistence  theory  of  wages,  437. 

Supply,  nature  of,  162;  relation  to 
normal  price,  167, 170. 

Supply  curve,  short-period,  163 ;  long- 
period,  174. 

Supply  and  demand,  156. 

Supply  and  demand  curves,  164. 

Surplus,  bank,  287  n. ;  insurance,  583 ; 
consumers',  161 ;  producers',  165 ;  of 
bargaining,  181,  442. 

Surplus  value,  doctrine  of,  629. 

Syndicalism,  631. 

Tabular  standard,  342. 

Tariff,  and  sectionalism,  63 ;  as  source 
of  revenue,  713.    See  Protection. 

Taxation,  694 ;  justice  in,  696 ;  progres- 
sive, 699;  direct  and  indirect,  702; 
shifting  of,  202,  703,  714 ;  federal,  710; 
state  and  local,  726. 

Taylor,  H.  C,  on  farm  tenancy  in 
England,  618. 

Tenancy,  farm,  increase  of,  603 ;  com- 
pared with  encumbered  ownership,  615. 

Time  utility,  116. 

Trade  arbitration,  457. 

Trademarks,  23,  196. 


Trade  unions.    See  Labor  organizations. 
Transactions,  taxes  on,  719. 
Transportation,  557.    See  Railways. 
Trust  companies,  314. 
Trusts,  230.    See  Combinations. 
Turgot,  745. 

Unearned  increment,  422. 
Unemployment  insurance,  592. 
Unfair  competition,  29,  239,  243. 
United  States,  economic  development  of 

61. 
United  States  Bank,  304  n. 
United  States  Steel  Corporation,  88. 
Urban  lands,  rent  of,  426. 
Urdahl,  T.  K.,  on  fee  system,  692. 
Use  price,  205. 
Usury,  493,  523.  743- 
Utility,  defined,  105. 
Utopian  socialism,  628. 

Valuation,  of  public-service  properties, 

184,  209  tt.,566. 
Value,  exchange,   152;    subjective,   137,. 

iS5;    production  of,  118.     See  Price. 
Values    of    money,     317.    See  General 

changes  in  prices. 
Variable   expenses,    relation    to    normal 

prices,  177. 
Vested  interests,  25. 
Victoria,  wage  boards  in,  459,  480. 
Voluntary  arbitration,  458. 

Wages,  as  price  of  labor,  427 ;  fixed  by 
demand  and  supply,  428;  affected  by 
structure  of  the  population,  432; 
affected  by  growth  of  population,  434 ; 
subsistance  theory  of,  437 ;  relation 
of  standard  of  life  to,  438 ;  in  different 
occupations,  439;  statistics  of,  in 
United  States,  341,  547;  agricultural 
wages,  606;  statistics  of  agricultural 
wages,  608;  in  greenback  period,  277. 

Wages  of  management.  See  Entre- 
preneur's wage. 

Wage  boards,  95,  459.  480- 

Wagner,  Adolph,  statistics  of  incomes 
in  Prussia,  546;  on  public  expendi- 
tures,  650. 

Waiting,  106 ;  an  ultimate  agent  of  pro- 
duction, 522;  relation  to  interest  rate 
499.521- 

Wants,  nature  of,  133. 

Wealth,  distinguished  from  income,  108. 


INDEX 


769 


Wealth  of  Nations.    See  Smith,  Adam. 
Weld,  L.  D.  H.,  on  state  regulation  of 

commission  merchants,  621. 
Wholesale  prices,  statistics  of,  341,  548. 
Willcox,  W.  F.,  on  growth  of  population, 

436. 


Willoughby,  W.  F.,  on  philosophy  of 
labor  legislation,  400. 

Women,  legal  regulation  of  labor  of,  479. 

Workmen's  compensation  laws,  British, 
57 ;  in  United  States,  488,  589 ;  stand- 
ards for,  590. 


A  A      000  099  979    7 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 


OCT  1  2  1986 


